I've noticed an increasing number of people contacting me about variable annuities lately. I think this can be explained by a fear increase among investors. In the past investors may have been willing to forego a guaranteed income stream for the chance at having substantially more assets during retirement. That mentality made sense at a time when the stock market averaged 10-12% growth per year and government entitlement programs were well funded. But during this ‘lost decade' investors find themselves clinging to cash and prioritizing guaranteed income over growth. Variable annuities actually offer both which is probably why investors are asking questions.
Variable Annuities are long-term investments designed for retirement. They may come with optional living benefits, which, for an additional fee, guarantee that the investor get back at least what they put into the contract through periodic payments—regardless of market performance. However, if the underlying investments (generally stocks and bonds) grow in value, the contract holder can ‘lock-in' a higher base from which to take income. An ideal scenario would work something like this: You put $100,000 in a variable annuity at age 60. The contract value grows to $200,000 over the next ten years. The contract value then declines to $140,000 over the next two years. Because of your living benefits rider, your income base locks in that $200,000 level and you are able to take 6% withdrawals for life, based on $200,000, at age 70. If you live to 95, you're guaranteed $12,000/year for 25 years, or $300,000 in payments, regardless of market performance.
Variable annuities are often criticized for being complex and expensive—both of which are true. Part of the reason why annuities often seem ‘too good to be true' is due to their complex nature. When you hear ads offering "Guaranteed Income for Life," that offer is real. But here are some good due diligence questions to ask a financial advisor prior to jumping in:
•How much income?
•At what age can I start taking that income?
•What goes to my beneficiaries if I die?
•How much does it cost me?
I'll answer those questions in order which will hopefully clarify to some extent how the insurance companies work and where you could potentially get trapped.
•The amount of income you get is based on your age. A typical variable annuity may offer you 5% of your income base for life if you start taking withdrawals at age 65. If you wait till 70, you may get 6% and if you wait for 75 or 80, you'd get 7%. Over the past few years, those numbers have become slightly less favorable for investors as the insurance companies have had a harder time ‘hedging' their riders and making money in the market with which to pay those guarantees. Obviously the exact terms of each payout vary from company to company.
•Like I mentioned above, the earlier you start taking income, the lower the percentage will be.