 Personal Finance PowerPoint Presentation, Variable Anuity. Prepare to get financially fit by practicing personal finance. Most of this information can be found at Investopedia Variable Anuity, which you can find online. Take a look at the references, resources, continue your research from there. This is by Akhilesh Ganti, updated April 30th, 2021. In prior presentations, we've been talking about insurance in general, then moving to the life insurance. Now we're looking at different kinds of annuities and within the context of that discussion, we're asking the question, what is a variable annuity? A variable annuity is a type of annuity contract, the value of which can vary based on the performance of an underlying portfolio of sub accounts. So an annuity, if you just think about the term annuity, it's basically a series of payments. When you're looking at an annuity as an investment, we're typically putting money into possibly in a lump sum or multiple payments into the investment, possibly with an insurance company. Hopefully that investment will grow. And then at some point, we're gonna get a series of payments in the future, possibly as part of our retirement plan or strategy. So oftentimes we're trying to get a series of payments that are gonna be somewhat dependable, which is why you wanna think about, usually with an annuity, the standard or baseline annuity to compare with would be the fixed annuity, which has more fixed components to it. And then look at some of the other kinds of annuities, such as a variable annuity. And we're typically looking at the ability of the annuity to kind of grow, which might have an impact on the amount of the payouts as well. With a fixed annuity, you got more of the portion that will have a fixed component to it with a variable annuity. As we can see here, we're gonna be tying it to the performance of an underlying portfolio, which gives us more potential exposure to gains if the market goes up, but it also, of course, the market could go down, which would possibly have a negative impact. So we could have less returns than we would have gotten in that case compared to like a fixed annuity would be the kind of idea. So sub-accounts and mutual funds are conceptually identical, but sub-accounts don't have ticker symbols that investors can easily type into a fund tracker for research purposes. Among annuities, variable annuities differ from fixed annuities, which provide a specific and guaranteed return. So that's why oftentimes when people think about annuities, you think about the fixed annuity first, because you might be working the annuity into your retirement contract and trying to have something that you could basically be very dependent upon. When you get to a variable annuities and you're basing the annuity on fluctuations in the market, that could be good because there could be a good outcome in the market, but you also have the risk involved, which could have a downside. So that's how you wanna balance those out when you're doing retirement planning. So understanding variable annuities, there are two elements that contribute to the value of a variable annuity. The principal, which is the amount of money you pay into the annuity and the returns that our annuities underline investment deliver on the principal over the course of time. So when you put the money into the annuity, like a lump sum, for example, into the annuity, that's like the principal that you're gonna be putting into it. It's gonna then be growing at some point and hopefully it's gonna be growing in this annuity because it's variable growing in alignment to some tying to market conditions or stocks that are picked a portfolio. The most popular type of variable annuity is a deferred annuity, often used for retirement planning purposes. It is meant to provide a regular, monthly, quarterly, annual income stream, starting at some point in the future. There are also immediate annuities which begin paying income right away. So usually when you set up an annuity, it would be nice if you could do it a little bit in advance so that you could put money into the annuity before the annuity starts paying out to you, meaning you're doing the investment side of things. You could, however, put money into an immediate annuity. So if you have a lump sum amount of money, you put it into the annuity and you start receiving the payments immediately, possibly hoping that in so doing, you could stretch that retirement nest egg out a bit by making an annuity from it. You could buy an annuity with either a lump sum or a series of payments and the accounts value will grow accordingly. And in the case of deferred annuities, this is often referred to as the accumulation phase. So the money is growing when you're putting money in and it's accumulating upward hopefully as it grows and you put money into it. The second phase is triggered when the annuity owner asks the insurer to start the flow of income, often referred to as the phase out phase. So now we're phasing out the annuity. Now you're not growing it. You're saying, I wanna take the money out of it, start paying me the money in annuity payments, poor, five or most annuities will not allow you to withdraw additional funds from the account once the payment phase has begun. So you can't really generally take the money out. That's one of the problems with the annuity because the point is that you've got the money in the annuity. You told the insurance company it's gonna be locked in there. What the insurance company is gonna do is they're gonna try to determine how much they're going to be earning on the money that you have locked in there and how much of that money they're gonna be paying you in accordance with whatever contract has been set up, which is a little bit more confusing because it's variable, but you can't get access to the money as easily as you could if you just had it in stocks and bonds for example, because that's the point of it being in the annuity. So variable annuities should be considered long-term investments due to the limitations on withdrawals. So you can't, if there's an emergency, you can't as easily just say, ah, just give me my money back in the annuity. If you had it just in the stock market, you could do that. But if you had it in the stock market, you also might have more exposures to losses if the stock market went down substantially. So typically they allow a withdrawal of each year during the accumulation phase. However, if you take a withdrawal during the contract's surrender period, which can be as long as 15 years, you'll generally have to pay a surrender fee. That's not good as with most retirement account options withdrawals before age 59 and a half will result in a 10% penalty. That's because you possibly got a tax advantage by putting the money into an annuity. So the IRS is trying to have you save for retirement if you took the money out before 59 and a half. They're saying you didn't save for retirement with it. So we're gonna penalize you for taking the tax advantage that we gave you and that's kind of the downside, of course, of that tax advantage component. So variable annuities versus fixed annuities. The fixed annuities is the one that you probably wanna keep as your baseline and then look at these more exotic kind of annuities from there. So the variable annuities were introduced in the 1950s as an alternative to fixed annuities which offer a guaranteed but often low payout during the annualization phase. The exception is the fixed income annuity which has a moderate to high payout that rises as the annuity tent ages. Variable annuities give buyers a chance to benefit from raising markets by investing in a menu of mutual funds offered by the insurer. The upside was the possibility of higher returns during the accumulation phase and a larger income during the phase out phase. So that's what they're trying to get little exposure to the market but of course the market could go up, they could go down. The downside was that the buyer was exposed to market risk which could result in losses. So that's, you know, you're giving up a little bit of a security on that and so you gotta weigh your pros and cons when you got your retirement planning. With a fixed annuity by contrast, the insurance company assumes the risk of delivering whatever return it has promised. Variable annuity advantages and disadvantages and deciding whether to put money into a variable annuity versus some other type of investment. It's worth weighing these pros and cons. Let's give pros on the pros side of things, tax deferred growth, income stream tailored to your needs, guaranteed death benefit on the con and then funds off limit to creditors on the con side of things. We've got the riskier than fixed annuities, surrender fees and penalties for early withdrawal and you could have some high fees for it in comparison to other possibly types of annuities and possibly if you just put money of course into just the stock market in an index fund, then you're typically gonna have less fees than you would with the insurance company with the variable annuity advantages. Number one, variable annuities grow tax deferred so you don't have to pay taxes on any investment gains until you begin receiving income or make a withdrawal. So that's similar to an IRA or 401K plan where the earnings could be deferred in taxes when you pull the money out then it might be subject to tax at that point in time. This is also true for retirement accounts such as traditional IRAs and 401Ks of course. Number two, you can tailor the income stream to suit your needs. I'm gonna tailor it to suit my jacket. Number three, if you die before the payout phase your beneficiaries may receive a guaranteed death benefit. So that's nice. It's kind of like a life insurance component in there as well. Although again, once you have these kind of overlaps on insurance and annuities and you're trying to invest in one thing that covers multiple kind of angles that's actually a little bit confusing because of what you would like to do most likely is put your investments and buy the thing you're trying to buy. That's like the straightforward way to do it. If I'm buying life insurance, I wanna buy life insurance. If I'm buying retirement savings stuff, I wanna buy retirement saving stuff. So the overlap can be a little bit confusing sometimes. Number four, the funds in an annuity are off limits to creditors and other debt collectors. This is also generally true of retirement plans. Disadvantages, number one, variable annuities are riskier than fixed annuities because the underlying investment may lose value, which isn't good. Number two, if you need to withdraw money from the account because of a financial emergency, you may face surrender fees. So it's not as easy to pull the money out. If you put the money in somewhere else it might be a little bit easier to pull the money out if you put it into like just stocks and bonds. If you put it under the umbrella of an IRA, then you also have some restrictions to it to just take the money out early as well because that's kind of a point of putting it into some kind of account that's gonna have a tax advantage thing. The IRS is saying you can't take it out until you retire. But even when you're taking the money out here, you're gonna get it in a stream of annuity payments, which again, could be kind of restrictive. You can't just pull all the money out generally. So any withdrawals you make prior to age 59 and a half may also be just 10% tax penalty. So number three, the fees on variable annuities can be quite hefty. So what's the bottom line in all this? Why don't you just get to the bottom of it? Before buying a variable annuity, investors should carefully read the prospectus to try to understand the expenses, risks and formulas for calculating investment gains or losses. Annuities are complicated products so that may be easier said than done. So obviously when you're looking at a contract like this, different lot of different variables in mind. So bear in mind that between the numerous fees such as investment management fees, mortality fees and administration fees and charges for any additional riders, a variable annuities expenses can quickly add up. That can adversely affect your returns over the long term compared with other types of investments. So other types of investments for retirement planning could be things like of course an IRA, a 401K plan. So you wanna keep your tax advantaged options in mind doing the appropriate comparing and contrasting and see what fits in for your particular needs.