The SEC recently published some guidance on variable annuities, an investment contract between an investor and an insurance company.
What It Is
A variable annuity is an investment account purchased from an insurance company that includes different types of insurance features. It can grow on a tax-deferred basis, and you can purchase one with a single payment or with regular “installment-plan” payments.
A variable annuity is an investment as well as insurance contract. Each annuity is unique, and they each have distinct features that make them different from other insurance or investment products.
Many of these features will have fees involved, so you must make sure you understand how it works before you make a purchase. These features may include:
- Insurance features, such as paying to a beneficiary upon your death
- Tax-deferred status until you make a withdrawal
- Annuitization that gives you regular payments, (i.e., monthly) protecting against you outliving your assets
The VA has two phases: the accumulation phase and the payout, or annuitization phase.
During the accumulation phase, you’re purchasing this annuity, either in one lump sum or with regular payments. Fees are taken out of the money you add to the account, and the remaining money is principal that’s invested in a number of options you can select from (typically mutual funds.) There may be regular monthly fees that are also taken out of the annuity.
The “payout” phase is when you choose to begin receiving payment from the annuity. It can be a lump sum (depending on the type of annuity) or regular monthly payments. These payments can be for a set amount of time, or they can be longer, such as your lifetime or that of your spouse. They payment amounts can be for a specific dollar amount, or vary based on the investment option’s performance.
Some are called “immediate annuities,” and you’ll begin to receive payments right after you purchase it.
However, once you begin receiving payments, you can no longer make a withdrawal.
As with most investments there are fees involved with this type of investment, as well as options that you purchase. These fees are discussed in the annuity’s prospectus, which you should review and read carefully before investing. Your investment advisor should also review the prospectus, clarify points and answer your questions.
The Risks Of A Variable Annuity
Like any investment, there are risks involved with a VA as well. Things to remember:
- A VA is a long-term investment vehicle, not short-term
- There are higher fees and expenses involved, such as surrender charges, contract and monthly fees, etc.
- You could lose your entire investment (especially if the company experiences difficulties later and can’t pay)
- There may be extra fees for special features, such as minimum income or a “death benefit” option
Fees will reduce your account value and the return on your investment, so it’s important to know what to expect. Unlike stocks and other types of investment, you may not be able to liquidate it immediately, and almost certainly lose a significant amount if you do.
As always, due diligence and research is key to knowing if a VA is right for you. Read the prospectus, of course, and understand what’s involved, including the fees involved. Consult with your investment representative and/or tax advisor to make sure you’re investing in something that is aligned with your overall investment objectives.
Variable Annuity Twisting
Variable annuities may give a financial advisor a substantial commission because variable annuities are intended to be held for many years. If your financial advisor recommends that you sell or replace an existing annuity, he may be engaging in a practice known as twisting or churning variable annuities to generate commissions.
You can review the SEC’s guidance here.
Have You Purchased A Variable Annuity?
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