What is a Variable Annuities

A variable annuity is essentially an insurance contract joined at the hip with an investment product. Annuities function as tax-deferred savings vehicles with insurance-like properties; they use an insurance policy to provide the tax deferral. The insurance contract and investment product combine to offer the following features:

• Tax deferral on earnings.
• Ability to name beneficiaries to receive the balance remaining in the account on death.
• "Annuitization"--that is, the ability to receive payments for life based on your life expectancy.
• The guarantees provided in the insurance component.

A variable annuity invests in stocks or bonds, has no predetermined rate of return, and offers a possibly higher rate of return when compared to a fixed annuity. The remainder of this article focuses on variable annuites.

A variable annuity is an investment vehicle designed for retirement savings. You may think of it as a wrapper around an underlying investment, typically in a very restricted set of mutual funds. The main selling point of a variable annuity is that the underlying investments grow tax-deferred, as in an IRA. This means that any gains (appreciation, interest, etc.) from the annuity are not taxed until money is withdrawn. The other main selling point is that when you retire, you can choose to have the annuity pay you an income ("annuitization"), based on how well the underlying investment performed, for as long as you live. The insurance portion of the annuity also may provide certain investment guarantees, such as guaranteeing that the full principal (amount originally contributed to the account) will be paid out on the death of the account holder, even if the market value was low at that time.

Unlike a conventional IRA, the money you put into an annuity is not deductible from your taxes. And also unlike an IRA, you may put as much money into an annuity as you wish.

A variable annuity is especially attractive to a person who makes lots of money and is trying, perhaps late in the game, to save aggressively for retirement. Most experts agree that young people should fully fund IRA plans and any company 401(k) plans before turning to variable annuities.