A variable annuity is an investment-based annuity where your money is invested in the market, and the value of your account rises or falls with those investments.
Understanding Variable Annuity in Plain English
A variable annuity is a type of contract you buy from an insurance company to help grow money for the future, often for retirement. Unlike fixed annuities, which promise a steady payout, a variable annuity lets your money be invested in things like stocks or stock-based funds.
Because the money is invested, the value of a variable annuity can go up or down over time. Your returns depend on how well the underlying investments perform.
This makes variable annuities appealing to people who want growth potential but are comfortable with some market risk.
How a Variable Annuity Works
When you buy a variable annuity, you make either a lump-sum payment or a series of premium payments. That money is then used to buy investment units, often called subaccounts.
Each subaccount works like a mutual fund and is tied to a specific investment strategy, such as stocks, bonds, or a mix of both. The value of each unit changes based on the performance of the investment portfolio.
If the investments perform well, the value of your variable annuity grows. If they perform poorly, the value can decrease.
A Simple Example
Imagine you invest $50,000 into a variable annuity. Your money is spread across stock-based subaccounts. Over the next few years, the stock market performs well, and your annuity grows to $75,000.
However, if the market declines, your account value might drop to $45,000 instead. That’s the trade-off with a variable annuity: higher potential growth, but more risk.
Variable Annuity vs. Fixed Annuity
A fixed annuity offers predictable income and stability. The insurance company guarantees a specific interest rate or payout.
A variable annuity, on the other hand, does not guarantee returns. Your income and account value depend on investment performance. This makes variable annuities more suitable for people with a longer time horizon who can handle ups and downs.
Optional Features and Guarantees
Many variable annuities come with optional riders, which are extra features you can add for a fee. Common riders include:
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Guaranteed minimum income benefits
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Death benefits for beneficiaries
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Protection against major market losses
These features can provide peace of mind, but they also increase costs. It’s important to understand what you’re paying for and whether the benefits fit your financial goals.
Fees and Costs to Be Aware Of
Variable annuities often come with higher fees than other investment products. These may include:
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Mortality and expense charges
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Investment management fees
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Administrative fees
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Rider costs
Over time, these fees can reduce overall returns, so it’s important to review them carefully before buying.
When a Variable Annuity Might Make Sense
A variable annuity may be a good fit if you:
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Want long-term growth for retirement
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Are comfortable with market risk
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Like the idea of tax-deferred growth
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Want optional income or death benefit guarantees
They’re usually not ideal for short-term goals or for people who want guaranteed returns.
Why Variable Annuity Matters
A variable annuity blends investing with insurance protection. It offers growth potential through market investments while giving access to optional guarantees that traditional investments don’t provide.
Understanding how a variable annuity works can help you decide whether it fits your financial plan. Like any financial product, it’s most useful when it matches your goals, risk tolerance, and time horizon.
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