Variable annuities are a type of investment that is sold by insurance companies. They offer tax-deferred growth and the potential for an income stream during retirement. In this article, we will go over exactly what variable annuities are, how they work, as well as their advantages and disadvantages.
A Brief Explanation
Variable annuities are entered into as a contract between you and an insurance company. It is an investment account and an insurance product in one. They allow your account to grow on a tax-deferred basis. They also offer the ability to turn on an income stream as well as a death benefit for your beneficiaries. When you purchase an annuity, you are able to choose from several different investment choices to put your money in. The value of your account will fluctuate depending on the performance of your investment choices.
Advantages of Variable Annuities
Every type of investment has both its advantages and disadvantages. Some of the advantages include:
- Growth Potential: Because you can choose how to invest the funds in an annuity, you have large growth potential.
- Tax-Deferred: Variable annuities also offer you tax-deferred growth. This means that your funds can grow, and you can make investment transfers with no current tax consequences. You are only responsible for paying taxes upon withdrawal of the funds.
- Death Benefit: Before you begin receiving payment, your variable annuity will typically offer a death benefit for your named beneficiaries.
Disadvantages of Variable Annuities
Before making any decisions, it is very important to fully understand its disadvantages. The disadvantages of variable annuities include:
- Investment Risk: The opposite side of growth potential is investment risk. Variable annuities typically do not provide any type of protection or guarantee. If the investments you choose underperform the value of your annuity will go down. This ultimately affects your retirement payout amounts.
- Penalties: They have built-in penalties or surrender charges. If you take out funds before the time set out in your contract, you will pay a percentage of that back to the insurance company as a surrender charge. This time period usually spans for several years. This makes variable annuities a long term investment.
- Fees: Variable annuities typically have steep sales commissions, as well as ongoing management fees and other charges. All of these eat into your account and have the potential to negatively affect your retirement.
Is a Variable Annuity Right for You?
If you have the right level of risk tolerance and a long-term investment time horizon a variable annuity may be right for you. But it is very important that you meet with a qualified financial planner who can help you determine if one is the right fit for you.
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