In having already understood the benefits and disadvantages of the fixed annuity, we can easily comprehend those of the variable annuity.
The advantages and disadvantages of the variable annuity are a bit more complex than that of the fixed annuity and will require a few more complicated terms and extra attention paid to conceptual details.
Fixed annuities are mainly built in order to shield you as much as possible from inflation while offering a safe haven for your money all the while giving it the opportunity to earn some money. However, the variable annuity is of a completely different design. So let’s look at the variable annuities pros and cons and see.
Advantages of Variable Annuities
Variable annuities are meant to allow your savings to grow quite a bit, beyond the level of inflation into the realm of true earnings and wealth growth. This is done over the long-term time period by allowing you a choice. Your investment company will already be investing in certain subaccounts, which are grouped stocks and bonds, acting very much like a mutual fund.
If you are comfortable with the idea of a mutual fund then you already understand most of the variable annuity. Choosing one of these subaccounts is important. You want to choose the one that seems like it will have best performance over the coming decades of your investment. While grouped, this also helps buffer you from loss by averaging out losses and earnings all the while hoping to average higher than lower.
A great benefit of this type of annuity is that you will not pay taxes on your earnings until you begin withdrawing your money, of course unless you withdraw prior to the agreed maturation time.
Benefits of Variable Annuities Over Fixed Annuities
The key concept to understand when comparing and contrasting a variable annuity against a fixed annuity is that you have the capability of taking on more risk but also assuming more benefit. You can profit in a big way with a variable annuity, but you can lose as well.
The growth potential on a variable annuity can far outpace the rate of inflation, where as with a fixed annuity you may find yourself not fully keeping up with it. You can gain purchasing power with variable annuities, while you are almost promised to lose some with fixed annuities. Choose wisely and do your homework first!
Disadvantages of Variable Annuities
Depending on you as an investor and your style, some of the negatives can outweigh the positives of variable annuities. For instance, the value of your variable annuity payouts can decline if the subaccounts you choose do not perform as well as you would hope.
There is also a penalty of ten percent for early withdrawal. You will also pay regular income tax on any of your earnings. So say you are a high roller who invents lots of capital gains into a variable annuity. You will later have to pay more taxes on those gains as income instead.
The final negative surrounding variable annuities are the fees. There are surrender charges, sales commissions up to three to four percent, and even continuing management fees. If you opt for insurance, you will pay recurring fees on that as well. These fees can dig into your profits big time.
Is a Variable Annuity Right For Me?
Your main goal in saving for retirement is to have tax deferred investments so you can pay taxes on them in retirement when your income will be lower and you will be classified in a lower tax bracket. So your first move should be maxing out contributions to 401(k) and IRA options. These do not feature the additional fees you will find with annuities.
Another type of investment you may want to look into before investing in a variable annuity would be an index fund. These can be tax-managed and may give you returns at a cheaper cost than an annuity may.