Variable annuities can be variable when looking at the account balance. Fees are deducted from the account value.
Compare owning a variable annuity-like going to the dentist, you know you will experience pain; you are not sure how much.
Variable annuities allow the owner considerable flexibility to invest annuity premiums in any way they see fit. The investor gets to keep the entire profit from gains and is liable to bear the loss for any decline in the price of invested holdings. The risks involved are the same as investments in stocks, bonds, or mutual funds.
So what is the difference here? The difference is that variable annuities are stock market investments with all the trappings of an insurance policy. All contributions and gains in a variable annuity are tax-deferred. If you are a professional in a sector with high-income potential, then annuities may help provide a sheltered savings tool.
The critical issue with annuities is that once you choose to annuitize the contract, the decision is final. You pay a lump sum amount to the insurance company, and in return, the company agrees to pay you a fixed monthly amount for the rest of your life. Now, who makes a profit here depends on how long you live. If you live for the next 20-30 years, you may end up getting more than what you paid. If, however, you pass away within a short period after annuitizing the contract, that leaves the company holding the balance of the enormous amount you paid.
Investments in annuities are tied up until age 59 ½, and early withdrawals are subject to a 10% penalty by the IRS. Also, investment gains are taxed upon withdrawal at ordinary income tax rates instead of long-term capital gains tax. Some companies will also charge surrender fees if you wish to change your annuity to another company. The fee will vary depending on the age of the annuity. Administrative changes and annual fees are buried into the cost of the contract and will be deducted from your profit. These charges average around 1.4% but can be as high as 3.5%, depending on the actual contract. Fees, expenses, and all details for the contract are available in the sales prospectus.
Variable annuities may have advantages over direct investments in stock markets but also have downsides. It is necessary to take a good look at how annuities work, the contract charges, how much flexibility you have, and the long-term gains. It is advisable to discuss your options with a financial advisor.