What is a variable annuity? Variable annuities have changed dramatically over the last 10 years. Although the basic chassis of most contracts are still the same, the features and benefits, on the other hand, have changed at an unprecedented pace.

The basics of variable annuities:

A variable annuity is a contract between you, the owner, and the insurance company. You agree to invest your money, and in return, the insurance company promises fixed or variable payments in the future. A variable annuity is not a life insurance contract; they may seem similar because it offers some type of death benefit. These death benefits are taxable to your heirs, unlike most life insurance contracts which offer tax free death benefits.

Most variable annuity contracts offer you a basic contract with features already built in. The basic benefits generally include: terminal illness benefit, nursing home waiver, liquidity (usually 10% of purchase premium), standard death benefits and, of course, tax deferral. These basic benefits can vary depending on the issuing company and the state where you live. You may also have additional benefits to choose from called optional riders.

Optional riders are additional guarantees you can purchase for a fee, on top of the standard benefits of the contract. These optional benefits may include: a bonus (the insurance carrier will add a certain percentage to your deposits), additional or enhanced death benefits, living benefits, shortened surrender schedule and in some cases, long term care provisions. All of these optional benefit costs will be added to your mortality and expense charges referred to as M&E charges.

All of the fees will be different depending on the benefits chosen, the state which you live, and the issuing insurance company. You must be careful with these optional benefits, as it can get expensive if you choose too many. Your best bet is to decide what you want the variable annuity to do for you and build the benefits you choose around that goal.

How to build your variable annuity:

If you are looking to guarantee your income, either now or in the future, then you may not need death benefit options at all. You would want to choose some type of living benefit. To understand living benefits better, sign-up for ‘Living Benefits Explained’ on this site. Most living benefits are optional riders and you must sign up if you want them, at the time of the annuity purchase. Rarely does the issuing company allow you to choose the living benefit after the issuing of the contract.

If you are looking to pass this asset on to your heirs, then choose from the death benefit options available to you, not the living benefits. Living benefits are built for you while you are alive, and not built to pass the asset on to your heirs. Death benefit options come in several flavors and there are plenty of options for you to choose from. These options will vary depending, on the state you live in and the company you decide to work with.

Your broker or agent does not get additional compensation for ANY of the benefits you choose. Therefore, if you want living benefits, the broker or agent will not discourage you from purchasing them unless they feel it is not appropriate. The myth the critics are spreading is that your advisor does collect additional compensation based on the benefits you choose and that is completely, 100%, false.

Considerations:

If you are investing a large sum of money, then you may wish to invest with a couple of different insurance companies. There is a rule called, the rule of aggregation. This means that if you invest in 2 different contracts at the same company, then they will be treated as one investment.

Example:

If you invest 1 million dollars into 2 contracts under the same company ($500,000 into 2 different contracts) and they both double (meaning you now have 1 million dollars in each contract equaling 2 million ) and you close out one contract, the IRS will view this as taking out profits and the whole 1 million you withdraw will be taxable.

If you invested $500,000 into 2 different companies and the money doubled in each contract (meaning 1 million in each contract equaling 2 million dollars total), and you close out one of the contracts, you will only be taxed on $500,000, not 1 million.

Several companies also have maximum benefit limits on living and death benefits. This means that once you reach this limit, you will not receive additional benefits or the benefit will just stop. Many of these limits are very high, $5 million is about the average limit, but it is possible to reach these limits.

Diversifying has its rewards and if you position yourself correctly, you will achieve your goals. These are the basic rules that you should review before you invest in any variable annuity. These rules, generally, only apply to those thinking of investing very large sums of money, $500,000 or more.

Variable annuities can be complex, but that is why we are here to clear the air and tell you what is what. No pressure, no sales calls and straight information is what Annuity IQ is all about.