Variable annuities can provide income in retirement and the potential for higher returns, but they also come with drawbacks such as higher fees, limited liquidity, and market risk.
Before making a decision, it’s essential to carefully consider the pros and cons of variable annuities to determine if they are the right choice for you.
Understanding Variable Annuities
A variable annuity is a contract between an individual and an insurance company that can offer income during retirement.
With variable annuities, the value is based on the performance of underlying investments, typically mutual funds. This means that the value of the annuity can fluctuate based on the performance of the chosen investments.
Variable annuities are more suitable for investors with higher risk tolerances who have already maximized other retirement plans.
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Pros and Cons of Variable Annuities
Variable annuities, like all annuities, come with various fees that may be charged annually based on the contract’s value. However, variable annuities have higher fees and risks, making it crucial to carefully consider if they align with your investment goals.
Here are some pros and cons to consider when evaluating a variable annuity:
Pros
- Provides income in retirement
- Offers growth potential
- Allows for tax-deferred growth
- Investment management is handled by the insurance company
Cons
- High fees
- Exposure to market risk
- Limited liquidity
- Potential issues with sales practices
Pros
One may find a variable annuity appealing if they seek retirement income with the chance for higher returns and possess a higher risk tolerance.
- Income in retirement: Variable annuities, like other annuities, offer a stream of income during retirement and beyond.
- Growth potential: Variable annuities present the opportunity for higher returns as the payouts are dependent on the performance of underlying investments.
- Tax-deferred growth: Earnings within variable annuities grow tax-deferred until withdrawal, similar to a traditional 401(k).
- Investment management: The insurance company manages the investments selected, alleviating the need for individual management.
Cons
It’s essential to be aware of the drawbacks associated with variable annuities, particularly the higher fees and market risks they entail.
- Fees: Variable annuities have higher fees compared to most annuities and other financial products due to the underlying investments and complex contracts, with fees typically ranging from 3 to 8 percent, excluding commissions and surrender charges.
- Market risk: The value of a variable annuity can decrease if the underlying investments perform poorly, exposing investors to market risks.
- Limited liquidity: Withdrawing funds from a variable annuity can be challenging once payments have commenced, as early withdrawals may incur surrender charges.
- Sales practices: Individuals may encounter insurance brokers or advisors who recommend variable annuities solely for the high commissions, ranging from 1 to 8 percent.
Conclusion
Deciding if a variable annuity is suitable for you depends on factors such as risk tolerance, time horizon, and financial objectives. While variable annuities can provide retirement income, it’s important to consider the high fees, strict contracts, and limited liquidity associated with them.