Fixed vs. Variable Annuities
Annuities are an often-forgotten tool when it comes to retirement income. It’s a contract between an individual and life insurance company where the annuitant (investor) pays premium either in one lump sum or periodically. In exchange, at a future date, the annuitant can receive a lump sum or periodic distributions that can continue for life. Since all earnings are tax-deferred, many individuals looking to accumulate additional retirement income can find an annuity to be a valuable tool. They come in many forms, but we are just going to keep things simple and focus on the main difference between fixed and variable annuities.
Fixed annuities guarantee a fixed rate of return. The individual will elect when they would like to begin receiving income and at that time the payout is determined by the account’s value and their life expectancy using a mortality table. The payout will remain constant for the rest of the annuitant’s life. Fixed annuities are not considered a security, but an insurance product, because the annuitant bears no risk since the rate of return is guaranteed. The loss of purchasing power due to inflation is the only drawback and “risk” the investor bears. For example, if the annuitant elected to begin receiving payouts of $750 per month in 1990, this amount may not be sufficient to live on a few decades later.
Variable annuities are a totally different animal. Premium payments go to the insurance company’s separate account where they will be invested in and be subject to fluctuations. The investor may choose to have their funds invested via money market or bonds, but most go with a stock portfolio to try to keep pace with, or beat, inflation. Since there is potential for much more gain than a fixed annuity, there is also much more risk, and no guarantee from the insurance company.
|Fixed Annuities||Variable Annuities|
|Fixed monthly payout||Variable monthly payout|
|Guaranteed interest rate||Variable rate of return|
|Risk assumed by insurance company||Risk assumed by annuitant|
|Portfolio of fixed-income||Equity, debt, money market portfolios|
|General account||Separate account|
|Vulnerable to inflation||Resistant to inflation|
|Insurance regulation||Securities and insurance regulation|
Keep annuities in mind when you find yourself looking for additional retirement income. They can be a very useful tool to provide solid investment returns, or guaranteed returns, and adds another flavor to your portfolio instead of the traditional stock, bond, or IRA investments. There are other forms of annuities that can be taken advantage of and there can be more to their investment than meets the eye. Stay tuned for more details on investing in annuities in upcoming posts.