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
During the accumulation phase, you can typically transfer your money from one investment option to another without paying tax on your investment income and gains, although you may be charged by the insurance company for transfers. Find out how often you can switch investment options each year. You might be limited to eight per year and with others they might not have a limit, enabling you to switch according to market swings. However, if you withdraw money from your account during the early years of the accumulation phase, you may have to pay “surrender charges,” which I will discuss in another post. In addition, you may have to pay a 10% federal tax penalty if you withdraw money before the age of 59½.
Payout Timeline
At the beginning of the payout timeline, you may receive your purchase payments plus investment income and gains (if any) as a lump-sum payment, or you may choose to receive them as a stream of payments at regular intervals (generally monthly).
If you choose to receive a stream of payments, you may have a number of choices of how long the payments will last. Under most annuity contracts, you can choose to have your annuity payments last for a period that you set (such as 20 years) or for an indefinite period (such as your lifetime or the lifetime of you and your spouse or other beneficiary). During the payout timeline, your annuity contract may permit you to choose between receiving payments that are fixed in amount or payments that vary based on the performance of mutual fund investment options.
How Long Will the Payout Last?
The amount of each periodic payment will depend, in part, on the time period that you select for receiving payments. Be aware that some annuities do not allow you to withdraw money from your account once you have started receiving regular annuity payments.
TER
Jeremiah John
If you enjoyed this post, then make sure you subscribe to my RSS feed.