Hidden Costs of Variable Annuities

June 23rd, 2010 Brian Smith Leave a comment Go to comments

Understanding Variable Annuities

A variable annuity is a financial product that is purchased by an individual from an insurance company. This type of investment allows the insurance company to pay the investor dividends either immediately or at a later date. The amount the investor receives in returns will be determined by various factors, such as how well the different investments that are a part of the annuity have performed. It is best that any person interested in variable annuities speak with a financial adviser in order to obtain more details on this investment option.

Characteristics of Variable Annuities

Variable annuities offer people the option of receiving payments throughout their life. Also, this type of annuity allows the beneficiary of the investor to receive a death benefit that is guaranteed to be equal to the amount of premiums that the investor paid, up until the time of death.

It is, however, important to realize that the overall value of this type of annuity is based on the market, so the amount earned can fluctuate considerably.

Accumulation and Payout of a Variable Annuity

There are two main phases of a variable annuity: The accumulation phase and the payout phase.

Accumulation Phase

The accumulation phase is the time period in which the annuity is building or growing funds. This period of accumulation is completely based on the amount of money that the investor is paying into the annuity and the growth that is occurring as a result of the market and the investments.

During the accumulation phase, there are a number of options that are available to investors. People are able to change their investment options during this stage and, if desired, place some of the money in a fixed account.

The accumulation phase does reveal some hidden costs of variable annuities, such as fees that may be charged as a result of changing your portfolio options.

There are also fees such as a surrender charge that is instituted when an individual withdraws money from the annuity in the beginning of the accumulation phase. Penalty fees related to the withdrawal of funds prior to retirement age also exist.

Payout Phase

The second phase of a variable annuity is the payout phase. This is the period where individuals are able to collect funds from the annuity. During the payout phase, individuals can choose to receive a lump sum payment of all monies earned and invested, or there is the option of having fixed payments that are made over a specified period or indefinitely.

The Hidden Costs of Variable Annuities

There are a number of hidden costs of variable annuities that should be noted before deciding to make an investment of this sort. One of the biggest disadvantages to the variable annuity is the IRS annuity penalty. This hidden cost usually occurs when people attempt to withdraw their funds before the age of fifty-nine and a half. If you try to take your money out before this date, a ten percent penalty is charged.

In addition, loss of capital is always a possibility when including equities in a variable annuity, as there is the risk that such products will not perform well in the market. Management and administrative fees are also prevalent when you purchase variable annuities.

Individuals should make sure to speak to someone in detail about their options and any fees when considering variable annuities as an investment option.

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