A variable annuity is a contract between an individual called an annuitant, and an insurance company, under which an insurer agrees to make periodic payments to the annuitant beginning either immediately, or at some future date. This is in return for a payment or series of payments to purchase the annuity.
Annuitants purchase annuities with the hope of earning a return on their investment. Returns on variable annuities are affected by factors such as:
When an annuitant purchases an annuity, the insurance company will invest the money in the bond, stock, money or other markets. The annuitant chooses where and how they want their money invested. The returns depend on the portion of the annuity invested in a particular account or market and the performance of that account or market. If the stock market is bullish the return on the annuity will be high if a significant percentage of the annuity is invested in the stock market. The opposite is also true is the market is bearish. If the bond market performs well the return on the annuity will also be good if a significant percentage of the annuity is invested in the bond market.
Bad investment choices
A bad investment decision will negatively affect the returns of the annuity. The bond market yields are between 1% and 2.5% in the US, UK, Japan and Germany and short term bond investment yields are even lower. If an annuitant decides to have a large chunk or all of the annuity in bonds, the returns will be very low. The distribution of the annuity to various accounts affect the returns.
Inflation has the effect of eroding the purchasing power of money. If inflation rises above the interest rate of the annuity, the real returns on purchasing the annuity will go into negative. As the rate of inflation increases, it eats into the purchasing power of the returns.
Fees and other charges
Insurance companies sell annuities because they want to make money out of it and not because they want to help annuitants. They will charge fees and or other administration charges on your annuity, which have the effect of reducing the returns. If costs exceed the returns, the annuity will be a loss making investment.
Age and Gender
When a young person purchases an annuity they will get lower income than an older person. Likewise, men receive a higher income than women. This is because of the projected life expectancy of different individual.
Time of withdrawal
If an annuitant starts withdrawing from the annuity before they reach the age of 59 ½ years, the IRS charges a penalty of 10% on the withdrawal. That tax will reduce the return.
Variable annuities are a good investment when the financial markets are performing well. Before an individual buys an annuity, it is advisable to first compare it with other forms of investment.