Explain a Variable Annuity

Variable annuities invest your money in instruments like stocks and bonds.

Variable annuities invest your money in instruments like stocks and bonds.

Annuities are financial instruments sold by life insurance companies that are typically used for long-term investment goals like retirement. With annuities, you make regular payments to the insurance company, which then invests it so it accrues interest. If you're the gambling type, you can put your money in a variable annuity, which is somewhat akin to investing in the stock or bond markets.

Identification

Annuities can either be fixed or variable. With a fixed annuity, your money earns a guaranteed interest rate for the life of the annuity. In contrast, the amount of interest you earn with a variable annuity can fluctuate. Your money is invested in financial instruments like stocks and bonds. This means that the value of your account can rise or fall rather quickly, so variable annuities may not be a good idea if you're not fond of roller coaster rides.

Process

During the accumulation phase, which is the time when you begin to make contributions until you begin to withdraw the money (like when you turn 65) you have the ability to allocate how your funds are distributed. Typically, you can move your money between mutual funds consisting of stocks and bonds or a fixed-rate account. Your money will grow on a tax-deferred basis, meaning you won't pay any taxes on interest earned until you begin to make withdrawals.

Getting Your Money

At the end of the accumulation period, your account "annuitizes," meaning you begin to receive payments. You can choose to receive your money in a lump sum or in payments at regular intervals. If you choose the latter option, you can also determine the time frame for receiving them, keeping in mind that the shorter the payment period you choose, the larger your payments will be. If you die before the end of your payment period, a designated beneficiary can continue to receive payments.

The Downside

Variable annuities are not all blue skies and candy canes. In addition to having to live with the fluctuating rates, variable funds also come with a litany of fees. The investment professional who sold you the fund will likely receive a nice commission. If you decide you can't wait until the minimum withdrawal age of 59 1/2, you'll also be hit with substantial surrender fees as well as a big tax hit. A portion of your investment amounts will also go to things like fund expenses and insurance fees.

About the Author

Chris Joseph writes for newspapers and online publications, covering business, technology, health, fitness and sports. He holds a Bachelor of Science in marketing from York College of Pennsylvania.

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