What is a Variable Annuity?
A variable annuity is an insurance contract, that guarantees a minimum payment after a set number of years or the accumulation period.
Variable Annuities also allow you to invest in the market through subaccounts. Within these subaccounts, there are different investment to choose from. These investments are similar to mutual funds inside the variable annuity. Investing in these different subaccounts allow the investor to capture some upside when the market is doing well, while the annuity protects them on the downside during the accumulation period.
Variable annuities provide investors with the security of an annuity combined with potential returns from different investments. Think of a variable annuity as a mutual fund with an insurance wrapper. This wrapper will protect your investment in the subaccount.
As annuities have become more popular, they have added new riders that offer an income guarantee for the investor. Many of these riders allow the investor to invest in the market through subaccounts in the variable annuity. This is a great option for investors as it lets them capture gains on the market during good years and protects usually with a guaranteed floor during the down years, such as 2008 and 2009.
Because of the recent Global Financial Crisis that happened in 2007 and 2008, many people are hesitant when it comes to jumping back into the market. The crisis has made many investors look for something with a “guarantee” that they will not lose their investment.

5 Questions to Ask Before You Buy an Annuity

Some financial advisors represent them to be the greatest thing since sliced bread.  Other advisors associate annuities with a certain four-letter word.  And no, that word isn’t good.
You might be wondering where I fall in the annuity camp.  Let’s just say that I’m somewhere in the middle.
Annuities, like any other investment, can make perfect sense in the right situation.  In the wrong situation they can be costly and even dangerous.
If you’re in the process of either buying an annuity or being sold an annuity by another advisor that you’re just not quite sure about, use this guide to help you make a better informed decision.  If you want a second opinion, I’m here for that as well.
Here’s what you need to know before you buy an annuity
1.   How long is the term of an annuity?
This will depend upon the type of annuity you choose, and the payout period that you require.
If you choose an immediate annuity you will fund the plan with an upfront lump sum investment, and then you can begin receiving income payments immediately after. Under a deferred annuity you will fund the plan over a number of years – typically the difference between your current age and projected retirement age – and then begin taking income payments either at the end of the specified term.
Beyond funding, your income payments can last as long as you choose. There are three principal types of income payment plans:
Lifetime Payments: This payout option will guarantee you an income during your lifetime, but it will won’t provide benefits to your survivors after your death.

Income for a Guaranteed Period: Under this payout option, you choose to receive payments for a specified period of time. In the event that you die before the end of the term, the benefit payments will continue, but be made to your survivors until the end of term.

Income for Life With a Guaranteed Period Benefit: This payout option combines elements of both of the above plans. You can choose to receive an income for a specified term, but if you die before the term ends, payments will continue to your survivors until the end of the term. If however you lived beyond the term, the plan will continue to pay you an income for the rest of your life.
2. What is a typical surrender charge?
Annuities typically come with surrender charges, and how much they will be will depend upon the insurance company you buy them through, as well as the point in the process at which you begin to withdraw your funds. These are similar to redemption fees charged by some mutual fund companies.
At the upper range, surrender charges can be as high as 8% to 10% of the value of the annuity, but again this will vary based on the insurance company.
The surrender charge is typically assessed if you begin withdrawing money from the annuity during the first few years after establishing the plan. They tend to work on a sliding scale, with the highest charge occurring during the first year of redemption. Eventually, the surrender charge will either drop to a much smaller level, or it’s will disappear completely.
Most annuities do provide what is commonly referred to as the “free withdrawal”.  Typically you’ll be allowed to withdraw 10% of your principal plus interest.   Once again read the fine print though.
Some annuities allow a 10% free withdrawal in the 1st year while others may make you wait until at least one year has passed.   Here’s a post that I wrote that talked about how to cash out an annuity.
3. Did the advisor who recommended the annuity really do their homework?
One of the challenges with annuities is designing a plan that will work best for you. In order for that to happen, your advisor will have to know a great deal about your financial situation, your future plans, and specifically what aspect of those plans you hope to cover with an annuity.
The advisor should want to know the answers to questions such as:
Are you looking primarily for income for yourself?
Do you have survivors who you are looking to provide for?
What is your investment risk tolerance?
What other investment assets do you have?
What other income sources will you have available?
If the advisor is merely putting you into some sort of general-purpose annuity, you have reason to be suspicious. Annuities contain a host of options and variables, from which your advisor should be able to construct a plan that is right for you.
Another important consideration is whether the advisor is compensated differently for the annuity they are recommending to you.   Many advisors claim to be independent but the reality is they can only represent a few different annuity providers.
4. Do you really understand all of the moving parts of an annuity?
Unlike mutual funds, annuities are actually investment contracts. That means they contain various provisions, and you need to be familiar and comfortable with those provisions before entering the agreement.
In addition to having an understanding of the income options and payout terms discussed above, you will also need to understand your investment options. For example, would you prefer a fixed annuity, in which the insurance company pays a fixed rate of interest for a specific period of time, much like a certificate of deposit. Or would you prefer a variable annuity, that includes sub accounts that function like mutual funds, and often provide a higher rate of return than fixed annuities will.
Still another option are indexed annuities that ties performance of the annuity to a specific equity-based index, in much the same way that index mutual funds function. But an indexed annuity often comes with a guaranteed minimum return that will limit the risk of loss in the event the stock index does poorly.
Be sure that you understand the terms and provisions of your annuity contract, and always ask your advisor for clarification on any points for which you are uncertain.
5. Is an annuity guaranteed, and if so, by whom?
It’s important to understand that there is no federal agency comparable to the Federal Deposit Insurance Corporation (FDIC) that ensures the principal value you have invested in your annuity. There is a risk of loss of some of the principal value of your investment. This is comparable to the risk that you assume when you invest in other risk type assets, such as stocks, bonds, mutual funds, and exchange traded funds.
In most states however coverage up to $100,000 is provided through what is known as a guarantee association. This is similar to the Securities Investors Protection Corporation (SIPC) in that it will provide a measure of protection in the event of a default by the insurance company. However unlike SIPC, the guarantee association is not a government-sponsored organization, but rather an industry arrangement provided by the various insurance companies that operate in a given state.
The strength of the issuing insurance company is important in the case of an annuity. In order to determine that, you can check a third-party source, such as A.M. Best, which is the most respected rating agency in regard to insurance companies. The strength of the insurance company that issues your annuity is your first, best protection against a defaulted plan.