A variable annuity is complex financial and insurance product that an investor should be fully aware of the risks, rewards, and features of before investing. In fact, recently the Securities and Exchange Commission (SEC) released a publication entitled: Variable Annuities: What You Should Know. The SEC encouraged investors considering a purchase of a variable annuity to “ask your insurance agent, broker, financial planner, or other financial professional lots of questions about whether a variable annuity is right for you.”
Essentially, a variable annuity is a contract with an insurance company under which the insurer agrees to make periodic payments to you. A variable annuity contract may be purchased by making either a single purchase payment or a series of purchase payments over time. The investor chooses the investments made in the annuity and value of your variable annuity will vary depending on the performance of the investment options chosen. The investment options for a variable annuity can vary but are generally mutual funds.
The three primary benefits of variable annuities are:
- Periodic Payments. These payments are made for the client's life or the life of a designated beneficiary;
- A death benefit. That is, if you die before the insurer has started making payments to you, your beneficiary is guaranteed to receive typically at least the amount of your purchase payments; and
- Tax-deferment. Meaning that the taxes on in the investment vehicle are deferred until the money is withdrawn.
However, the benefits of variable annuities are often outweighed by the terms of the contract including surrender charges, mortality and expense charges, management fees; market-related risk, and rider costs. Variable annuities are high sales commission products for financial advisors and sometimes advisors push these products on persons who do not need them or cannot benefit from them. For example, a tax-qualified account such as an IRA would be unsuitable for holding a variable annuity investment because an IRA is already tax deferred.
The SEC publication also warns against the risks of “bonus credits” offered by some variable annuity products. The bonus credit is often an insurance company match of the purchase amount of the annuity. While the additional funds seem attractive, the SEC warned that often times the insurance company comes out ahead through back-end surrender charges, longer surrender charges; and higher ongoing mortality and expense charges.