Five key questions to ask yourself about fixed and variable annuities.
While fixed annuities are generally considered to be conservative instruments, variable annuities are investments with the growth potential necessary to outpace inflation, but generally carry a higher degree of risk.
If you have decided an annuity fits your overall investment strategy, the decision as to whether a fixed or variable annuity is more appropriate hinges on your answers to several key questions, among them:
1. Would you like to have the opportunity to choose investment options? With a fixed annuity, the insurance company takes on all investment decisions; you have essentially traded decision-making for a fixed promise to pay.
On the other hand, with a variable annuity, you choose from a menu of investment options (usually including funds of the sponsoring company) and have essentially exchanged a guaranteed result for the right to exercise investment direction. With a variable annuity, you bear a greater amount of risk; consequently, the cash value of a variable annuity contract is not guaranteed.
2. How much risk are you willing to accept to accomplish your investment goals? Fixed annuities are considered conservative investments, but you may sacrifice potential growth for low risk and certainty of return. Variable annuities are considered higher risk investments, offering less certainty in the pursuit of potentially greater growth.
3. How important is diversification to your investment portfolio? All investments carry a measure of risk, but you can help reduce some of this risk through diversification.
4. What other factors should you consider? First, a variable annuity grows on a tax-deferred basis. In contrast, for example, periodic distributions from a regular mutual fund are subject to annual taxation, even if reinvested in additional shares. Second, a variable annuity offers a lifetime payout option, while a mutual fund account does not. Finally, variable annuities provide a guaranteed minimum death benefit (guaranteed by the claims-paying ability of the issuing insurance company).
While these three factors might appear to favor annuities, mutual funds do have their own advantages. Most mutual funds avoid early withdrawal penalties, while, there may be some early surrender charges associated with annuity accounts. Also, overall fees may be lower with mutual funds, since annuity contracts involve mortality and expense risk charges associated with providing a death benefit guarantee and administrative services. Lastly, a variable annuity may offer only a limited number of investment options.
Evaluating the risks – and knowing your own risk tolerance – are important elements in the process of “trading off” risk and reward, and should guide the decision as to which investments are appropriate for you. Fixed annuities, variable annuities, and regular mutual funds are not mutually exclusive. There is room for all three in a well-diversified portfolio.
Taken together, they may provide an investment mix with a good combination of low risk, growth potential, liquidity, and payout options. However, keep in mind that principal value and rate of return in both a variable annuity and a mutual fund will fluctuate according to market conditions.
A prospectus containing more complete information including charges and expenses should always be read carefully before investing.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
Fixed and Variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value.
Investing in mutual funds involves risk, including possible loss of principal. The funds value will fluctuate with market conditions and may not achieve its investment objective. Upon redemption, the value of fund shares may be worth more or less than their original cost.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.