What is the main difference between a variable annuity and a fixed annuity?

The main difference lies in investment risk and growth potential. A fixed annuity offers a guaranteed interest rate and predictable income, with the insurance company bearing the investment risk. A variable annuity allows you to invest in subaccounts, offering market-driven growth potential but also exposing you to market risk, though optional riders can provide some guarantees.

Are variable annuities a good investment for retirement?

Variable annuities can be a good investment for specific individuals, particularly high-income earners who have maximized other tax-advantaged accounts and prioritize tax-deferred growth with the option for guaranteed lifetime income. However, their high fees and complexity mean they are not suitable for everyone, especially those with shorter time horizons or who prefer low-cost, liquid investments.

What fees are typically associated with variable annuities?

Variable annuities typically have multiple layers of fees, including mortality and expense (M&E) charges (0.75%-1.50%), administrative fees, subaccount management fees (0.50%-2.00%), and additional fees for optional riders (0.25%-1.00+%). Total annual fees can easily range from 2% to 4% or more of your account value.

How are withdrawals from a variable annuity taxed?

Withdrawals from a non-qualified variable annuity are taxed as ordinary income on the earnings portion, following the "last in, first out" (LIFO) rule. This means earnings are taxed first, then your tax-free principal. If the annuity is in a qualified retirement plan (like an IRA), all withdrawals are taxed as ordinary income. A 10% IRS penalty may apply to withdrawals before age 59½.

Can I lose money in a variable annuity?

Yes, you can lose money in a variable annuity. The value of your investment is tied to the performance of the underlying subaccounts, which are subject to market fluctuations. If your subaccounts perform poorly, your account value can decrease. However, many variable annuities offer optional riders, such as guaranteed minimum withdrawal benefits or death benefits, which can provide some protection against losses or ensure a minimum payout.

What is a surrender charge and how long does it last?

A surrender charge is a fee imposed by the insurance company if you withdraw money from your annuity or cancel the contract during an initial period, typically 5 to 10 years after purchase. These charges are designed to recoup sales and administrative costs and usually start high (e.g., 7%) and gradually decline over the surrender period.

Should I buy a variable annuity if I already have a 401(k) or IRA?

Generally, it's advisable to maximize contributions to your 401(k) and IRA first, as these accounts offer similar tax advantages with typically lower fees and greater flexibility. A variable annuity might be considered *after* you've fully utilized these options and are looking for additional tax-deferred growth opportunities or specific income guarantees that align with your retirement goals.

Variable Annuity Guide: Benefits, Fees & Retirement…