Two Timelines
An accumulation variable annuity has what I call two timelines. The first timeline is an accumulation period of time. The second timeline is a payout period. There are also immediate variable annuities. which means that there is no accumulation timeline and you will start receiving annuity payments right after you purchase the annuity.
During the accumulation timeline, you will make purchase payments, which you can allocate to a number of investment options. For instance, you could designate 40% of your payments to an international stock fund, 40% to a U.S. stock fund, and 20% to a bond fund. Depending upon your age you might weigh your investments to more equity (stocks) and less to bonds (income). The money you have allocated to each mutual fund investment option will increase or decrease over time, depending on the fund’s performance. In addition, variable annuities often allow you to allocate part of your purchase payments to a fixed account. A fixed account, unlike a mutual fund, pays a fixed rate of interest. The insurance company may reset this interest rate periodically, but it will usually provide a guaranteed minimum (e.g., 3% per year).
Example: You purchase a variable annuity with an initial purchase payment of $10,000. You allocate 50% of that purchase payment ($5,000) to a bond fund, and 50% ($5,000) to a stock fund. Over the following year, the stock fund has a 10% return, and the bond fund has a 5% return. At the end of the year, your account has a value of $10,750 ($5,500 in the stock fund and $5,250 in the bond fund), minus fees and charges (which I will discuss in another post).
Read Your Prospectus
Your most important source of information about the variable annuity investment options is the prospectus – what I refer as the documentation. Request the prospectuses for the mutual fund investment options. Read them carefully before you allocate your purchase payments among the investment options offered. You should consider a variety of factors with respect to each fund option, including the fund’s investment objectives and policies, management fees and other expenses that the fund charges, the risks and volatility of the fund, and whether the fund contributes to the diversification of your overall investment portfolio.
Caution: Look over all the documents – prospectus – you receive when talking to the variable annuity agent and take your time reading about what kinds of investments they buy, and how often they might change their portfolio, also known as turnover. The documentation provides general information about the types of mutual funds and the expenses they charge. Don’t be shy about asking the agent how much or what percent commission they will make if you buy. This can vary from company to company, and it is part of your decision making process.
Switching Investments Continue reading How Variable Annuities Work