Variable Annuities FYI

      A variable annuity is a type of financial product designed to provide scheduled payouts of deposits plus interest over a defined time period. Typically, an annuity is designed to provide a steady income flow deferred until an individual's retirement, but can also begin to pay out immediately, such as in the case of a court settlement. When purchasing a variable annuity, an individual can choose to invest a lump sum of money or make steady payments toward the contract over time, which accrues along with interest and begins to pay out at a predetermined time, usually at the time of the contract holder's retirement.

      Variable annuities have two phases, or stages. The first phase is the accumulation phase, in which the annuity gains value through payments made to the account. During the accumulation phase, the annuity appreciates in value through interest payments. Unlike a fixed annuity, where the interest rate is set in the contract, interest in a variable annuity is tied to a chosen investment option. Typically, these options include mutual funds, stocks, and bonds. The level of your interest payments is tied to the performance of the chosen investment; if a mutual fund tied to your account increases in value, your interest rate will proportionally increase based on the percentage of your account tied to the mutual fund. The investor has the choice of allocating a certain percentage of the variable annuity to one (or more) investment options. For example, 40% could be tied to a certain mutual fund, 30% to a bond, and 30% to a selected stock.

      The second phase of a variable annuity is the payout phase. As the name implies, the investor starts to receive payments plus any gains as a lump sum or series of payments. These payments can be structured to last for a preset period or indefinitely, until the death of the contract holder. The value of the payment is determined, in part, by the length of time over which the annuity is paid out. Payments will be higher over a shorter payout phase than an indefinite phase, in most cases. In addition, you may choose to have your payment fixed or tied to the performance of the mutual fund or other investment. Keep in mind, though, that the performance of the chosen investment option is not guaranteed.

      When looking to purchase a variable annuity, the most important things to consider are fees. Variable annuities have a large number of fees associated with them, including fees for early withdrawal, administrative fees, risk charges, and many others, in addition to taxes on withdrawals. Depositing money into an annuity is typically a one way street; the investor cannot withdraw funds until age 59 ½, and there are high fees associated with early withdrawals. If you are considering an annuity, also look at the financial strength of the company. Firms such as Moody's and S&P provide rankings of insurance companies, be sure to consult these to ensure that your chosen firm is stable. Look for a firm and annuity account that best fit your investment style as well. If you are more conservative, or planning to retire soon, a more conservatively-skewed variable annuity may be best, rather than a more risky investment.

Sources:

http://www.sec.gov/investor/pubs/varannty.htm

http://www.csmonitor.com/Business/Christian-Personal-Finance/2010/0329/Pros-and-cons-of-variable-annuities

http://www.prudential.com/view/page/public/11629