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What is a variable annuity?


An annuity is a contract in which an investor turns over a sum of money to an insurance company, either all at once or in periodic payments, and in return the insurer repays the money to the investor, known as the annuitant, either for a certain number of years or, more often, for life. Annuities are usually bought to fund retirement, and that’s when the payments usually start. There are tax advantages to annuities and often death benefits for surviving spouses. Annuities are popular because lifelong payments ensure that annuitants won’t outlive their money, or at least that chunk of it.

In one type of annuity, the insurer keeps the money in safe, interest-bearing assets and makes fixed payments in amounts based on the life expectancy of the annuitant and on such factors as the general level of inflation and interest rates. In a variable annuity the money is invested in stock and/or bond mutual funds in proportions determined by the annuitant. At the end of this phase of the contract, the annuitant can get the money back in a lump sum or take regular payments. If regular payments are chosen, the amount can be fixed, as with a conventional annuity, or the money can remain invested in the markets and the payments can vary based on market returns.

Because the payments can fluctuate, variable annuities are more risky, but some contracts have clauses mandating minimum payments. Keep in mind, though, that such a guarantee costs money, and annuities generally have high fees that can be difficult to understand. Some financial advisers think that people are better off using tax-favored retirement vehicles like 401(k) plans or individual retirement accounts, which tend to have much lower expenses, and then purchasing a fixed-rate annuity when they want a steady income stream in retirement.

-Conrad de Aenlle