Variable Annuity

Definition

A variable annuity is a type of insurance product that provides future payments to the contract holder, with the potential for the payouts to vary based on the performance of underlying investments. The contract holder invests in a selection of portfolio options, often referred to as sub-accounts, which comprise mutual funds or other investment vehicles. The value of this retirement savings tool depends on the performance of these chosen sub-accounts, and thus, the income payments may fluctuate over time.

Phonetic

The phonetics of the keyword “Variable Annuity” are: Variable: ˈvɛərɪəbəlAnnuity: əˈnjuːɪti

Key Takeaways

1. A variable annuity is a type of long-term investment product designed to provide investors with an opportunity for capital growth, income generation, and a potential death benefit. It combines the features of an insurance contract with an investment portfolio, allowing the investor to allocate their investments among various sub-accounts that consist of stocks, bonds, and other securities.
2. Variable annuities offer tax-deferred growth on investments, meaning that the earnings generated within the annuity are not taxed until they are withdrawn. This allows investors to potentially accumulate more earnings over time, as their investments can grow without being reduced by taxes. Additionally, variable annuities can provide a lifetime income stream through annuitization or through optional riders such as lifetime income benefits.
3. Despite the benefits, variable annuities may not be suitable for everyone. They can be complex products with high fees and surrender charges, which may outweigh the potential tax advantages and income benefits for some investors. It is essential for individuals to carefully consider the costs, their individual financial situation, and investment goals before purchasing a variable annuity.

Importance

Variable annuity is an important business/finance term as it refers to a type of long-term investment vehicle specifically designed to provide an income stream for an individual in retirement, while also allowing for potential growth of that investment. Unlike fixed annuities, which guarantee a predetermined rate of return, variable annuities give investors the opportunity to allocate their funds among various investment options, such as stocks, bonds, and money market instruments. This enables investors the potential for higher returns based on market performance, and at the same time, it exposes them to inherent market risks. Therefore, variable annuities play a critical role in retirement planning by providing a possibility of tax-deferred growth, a lifetime income stream, and a level of flexibility in adjusting the investment portfolio to better suit an individual’s financial goals and risk tolerance.

Explanation

A variable annuity serves as a versatile financial planning tool, designed to provide long-term income, capital appreciation, and a source of wealth transfer in retirement. This multi-faceted investment vehicle not only helps investors accumulate wealth on a tax-deferred basis, but also offers the flexibility to allocate assets across a broad range of investment options suited to an individual’s risk tolerance and financial goals. The primary purpose of a variable annuity is to generate an income stream that lasts through retirement by offering payout options such as periodic, fixed, or lifetime payments. This investment product can be particularly beneficial for individuals seeking to supplement their retirement income or meet other long-term financial objectives. As the name suggests, variable annuities fluctuate in value, as returns are based on the performance of the underlying investment options chosen by the policyholder. Investment options typically include equities, fixed income, money markets, and other alternative asset classes. This allows investors the opportunity to participate in potential market growth while maintaining an element of control over their risk exposure. Another appealing feature of variable annuities is the availability of optional riders, such as living and death benefit guarantees, that can provide income protection and wealth transfer benefits to the policyholder and beneficiaries. While variable annuities can offer significant benefits, investors should weigh the potential risks, such as market volatility and investment losses, against the potential rewards, while considering fees and charges associated with these products.

Examples

1. Retirement Investment: John, a 60-year-old investor, decides to purchase a variable annuity to provide him with income during retirement. He invests $100,000 in a variable annuity contract that offers a range of investment options, such as stocks, bonds, and money market investments. As the performance of these investments varies over time, the payouts John receives during retirement will fluctuate based on their returns. 2. Wealth Accumulation for High Net Worth Individuals: Sarah, a high net worth individual, has a well-diversified financial portfolio. Her financial advisor recommends a variable annuity as an additional tax-deferred investment vehicle. Sarah chooses a contract with an array of investment options, such as large-cap stocks, international equities, and corporate bonds. Her variable annuity’s value will increase or decrease based on the performance of the selected investments. This provides her with the opportunity to grow her wealth further while also mitigating the risk through diversification. 3. College Savings Plan for Children: Dave and Karen decide to start saving for their children’s college education. They learn about variable annuities as a potential long-term, tax-deferred investment option. They consult with a financial advisor and choose a variable annuity plan that offers a mix of growth stocks, sector funds, and bond funds. Dave and Karen contribute periodically to the annuity, and the investment performance of their chosen options determines the growth of their college savings. The variable annuity provides them with flexibility and the potential for higher returns as compared to traditional fixed annuities.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Investment Options (Subaccounts)
• Mortality and Expense Risk (M&E) Charges
• Deferred Variable Annuity
• Guaranteed Minimum Withdrawal Benefit (GMWB)
• Surrender Charges

Sources for More Information

• Investopedia
• Annuity.org
• Forbes
• Morgan Stanley