Fixed or Variable Annuity?
By Kristi Vaughan
Now that you have decided to make annuities part of your financial plan, the next decision is choosing between a fixed or variable annuity.
Fixed annuity
A fixed annuity earns a fixed rate of return and you are guaranteed a fixed payment when you begin receiving income.
Some fixed annuities are based on the performance of an equity index. In these cases, you receive a guaranteed minimum payout but could receive more if the index rises and the investment grows at a rate greater than the guarantee. The indices are usually widely-reported common stock indices such as the Standard & Poor’s 500 Composite Stock Price Index.
Variable annuity
As the name implies, variable annuities have the potential for fluctuation in value and payout. When you purchase a variable annuity from an insurance company, the insurance company invests your premiums in stock and/or bond funds, depending on the annuity contract. Because these markets can go up or down, so will the amount of your investment.
When you reach the payout phase of a variable annuity contract you will, in most cases, have an option of fixed or variable payments. These payments could be greater or lesser depending on the performance of the funds in which the annuity is invested.
Variable annuity and mutual funds differences
Unlike mutual funds, variable annuities give you the option of a lump sum payout at the end of the contract or periodic payments for the rest of your life – essentially protecting you against the possibility that you will outlive your retirement assets.
Additionally, with annuities, you get a guaranteed death benefit, which generally means that your designated beneficiaries (spouse, son, daughter or whomever) will get at least as much as you have invested, even if the account value is less at the time of your death.
Questions to ask in purchasing annuities
The Securities and Exchange Commission suggests you consider the following questions before buying an annuity:
- What are you using the annuity for (e.g. retirement or similar long-term goal)?
- Are you investing through a qualified retirement plan where the investment is already tax-deferred?
- Are you willing to risk a decline in value of your investment?
- Do you understand the features, fees, charges etc.?
- Will you be invested long enough to avoid surrender charges?
- Have you talked with your financial and tax advisors about the potential tax and other effects of the annuity?
