Variable Annuities

Lesson

Variable annuities are insurance products that allow investors to accumulate tax-deferred savings while providing a future stream of income. These annuities invest in various underlying investment options, such as stocks, bonds, and money market funds, which can result in fluctuating returns. The performance of the underlying investments determines the value of a variable annuity, and the investor bears the investment risk.

Practice Question #1

Which of the following best describes a variable annuity?

Terms

Variable annuity:

An insurance product that provides a future income stream based on underlying investments' performance.

Accumulation phase is when an investor contributes to a variable annuity, and the account value grows tax-deferred.:

Annuity phase:

The period during which the variable annuity provides a stream of income to the investor.

Death benefit:

A feature of variable annuities that guarantees a minimum payout to beneficiaries upon the annuity owner's death.

Surrender charge:

A fee the insurance company charges if an investor withdraws funds from a variable annuity before a specified period.

Subaccounts:

The underlying investment options available within a variable annuity.

Guaranteed minimum income benefit (GMIB):

An optional rider that guarantees a minimum income level during the annuity phase, regardless of the performance of the underlying investments.

Guaranteed minimum withdrawal benefit (GMWB):

An optional rider that guarantees a minimum level of withdrawals during the accumulation phase, regardless of the performance of the underlying investments.

Guaranteed minimum accumulation benefit (GMAB):

An optional rider that guarantees a minimum account value after a specified period, regardless of the performance of the underlying investments.

Expense ratio:

The annual fee the insurance company charges to cover the costs of managing the variable annuity and its underlying investments.

Practice Question #2

What is the primary difference between a fixed annuity and a variable annuity?

Do Not Confuse With

Fixed annuities:

Insurance products that provide a guaranteed rate of return and a fixed income stream during the annuity phase.

Practice Question #3

Which optional rider guarantees a minimum level of income during the annuity phase of a variable annuity, regardless of the performance of the underlying investments?

Historical Example

In the 1990s, variable annuities gained popularity as investors sought higher returns from the stock market. However, many investors did not fully understand the risks associated with these products, and some experienced significant losses during the market downturn in the early 2000s.

Real-World Example

An investor nearing retirement may choose to invest in a variable annuity to provide a future income stream. They contribute $10,000 per year for 10 years during the accumulation phase. At the end of the 10 years, the account value has grown to $150,000 due to the performance of the underlying investments. The investor then begins receiving monthly income payments during the annuity phase, which will vary based on the continued performance of the investments.

Rhyme

GMIB ensures income, a minimum it'll cite, GMWB allows withdrawals, guaranteeing despite. GMAB's the protector, of your investment site, Each provides a safety net, giving investors respite.