Variable annuity

Definition

A variable annuity is a type of retirement investment product offered by insurance companies.

What is variable annuity?

Annual annuity allows individuals to invest a lump sum or make periodic payments in exchange for a series of periodic payments in the future, typically during retirement. Here are some key points about variable annuities:

1. Investment component:
– Unlike fixed annuities, which offer a guaranteed return, variable annuities allow individuals to invest in a range of underlying investment options, such as mutual funds or sub-accounts.

2. Market-linked returns:
– The performance of a variable annuity’s investments is tied to the financial markets. This means that the value of the annuity can fluctuate based on the performance of the chosen investment options.

3. Tax-deferred growth:
– Earnings within a variable annuity grow tax-deferred. This means that individuals do not have to pay taxes on the gains until they begin withdrawing the funds.

4. Customisable investment choices:
– Variable annuities typically offer a selection of investment options, allowing investors to choose a mix of stocks, bonds, and other assets based on their risk tolerance and investment goals.

5. Guaranteed minimum death benefit:
– Many variable annuities come with a guaranteed minimum death benefit. This ensures that, in the event of the annuitant’s death, a specified minimum amount will be paid out to the beneficiary.

6. Optional riders:
– Variable annuities often offer optional riders (add-ons) for additional features, such as guaranteed income for life, enhanced death benefits, or long-term care benefits. These riders may come with extra costs.

7. Surrender charges:
– Variable annuities may have surrender charges if the investor decides to withdraw a significant portion of the funds within a specified period after the initial investment. These charges typically decrease over time.

8. Income options:
– During the distribution phase, variable annuities provide various payout options, including periodic payments for a specified period or for life. The amount of payments can vary based on investment performance.

9. Considerations:
– Variable annuities are complex financial products and may not be suitable for all investors. They can have higher fees compared to other investment options, and it’s important to carefully review the terms, fees, and investment choices before purchasing.

10. Regulation and oversight:
– Variable annuities are regulated by government agencies and overseen by financial regulatory bodies to protect investors’ interests.

11. Long-term financial planning:
– Variable annuities can be part of a long-term retirement strategy, providing a potential source of income during retirement years.

It’s important for individuals considering a variable annuity to carefully assess their financial situation, investment objectives, and risk tolerance before making a decision. Consulting with a financial advisor who is well-versed in annuities can be beneficial in determining if a variable annuity aligns with their overall retirement planning goals.

Example of variable annuity

Imagine you’re nearing retirement and want to ensure a steady stream of income during your golden years so you decide to invest in a variable annuity.

You purchase a variable annuity from an insurance company, investing £100,000. With a variable annuity, your investment is allocated into various sub-accounts, similar to mutual funds, which invest in stocks, bonds, or other securities. The performance of these sub-accounts determines the value of your annuity.

Over time, the value of your annuity may fluctuate based on the performance of the underlying investments. If the sub-accounts perform well, your annuity value may increase, potentially leading to higher payouts in the future. However, if the investments perform poorly, your annuity value may decrease, affecting your future income.

When you reach retirement age, typically around 65, you can start receiving regular payments from your variable annuity. These payments can be fixed or variable, depending on the terms of your annuity contract.