Variable annuities are income-generating insurance products that provide you with various guarantees designed to protect your investment. Some people mistakenly believe that variable annuities cannot lose value over the course of time. In fact, while insurers may offer you money back guarantees, such clauses usually have caveats and you are unlikely to get your money back as a lump sum if you invest just prior to a stock market downturn.
Insurance companies invest your annuity premiums in mutual funds. Like any such funds, these may contain stocks, bonds, real estate holdings or even other insurance contracts. The subaccounts inside your variable annuity lose money whenever the underlying securities drop in value. Theoretically, your variable annuity could become worthless if your insurance company makes really poor investment decisions. On the other hand, your annuity grows in value any time that the prices of the underlying stocks and bonds increase. If and when you cash-in your variable annuity, you receive the market value of these subaccounts.
Standard variable annuity contracts include a death benefit rider, which means that your heirs receive a return of your premium if you die before the end of the contract. Your beneficiaries receive this sum of money regardless of the performance of the contract and this leads some people to think that these contracts cannot lose value. However, the money your beneficiaries receive actually comes from an insurance contract that you pay for with annual premiums that are deducted from the subaccounts. You could achieve the same effect investing directly in stocks and bonds and buying a life insurance contract on yourself for a sum equal to your initial investment.
Aside from the death benefit, many annuities include optional riders that are basically other types of insurance that protect your investment. Many firms provide you with riders that guarantee a return of premium in the event that your annuity loses value. However, you receive this money in the form of income payments that are designed to last for the duration of your life. If you ask for a lump sum payment you only receive the actual cash value of the annuity that may not amount to much.
Aside from stock market downturns and death benefit fees, variable annuity owners also have to pay for riders, annual operating fees and charges for buying the funds that are held in the account. On an annual basis, you may lose 3 or 4 percent of your investment to various charges. Even in an up market these fees can greatly reduce your earnings. One way or another, variable annuities always cost you money regardless of the performance of the stock market.