There are actually two categories of annuities: immediate annuities and deferred annuities. People who purchase an immediate annuity deposit a lump-sum amount and immediately receive a monthly payment until their death. Deferred annuities involve investing money and having it grow until the money is taken out. In variable annuities, the money is invested in mutual funds through sub-accounts (this is known as the accumulation phase) and then distributed to the investor (during the distribution phase) either as a one-time lump sum payment or over a period of time.
There are some benefits to variable annuities; however, unfortunately some unethical financial advisors mislead investors as to the real benefits of the annuities. Thus, many people invest in variable annuities thinking they are much better (or appropriate for their individual circumstances) than they actually are. Among the actual benefits are the tax-deferred status and guaranteed income for life.
However, along with the good comes the bad, and it is the bad that is often neglected in sales pitches. One of the first negatives is that once the contract is annuitized it is frozen. So, for example if you have invested $300,000 and agree to even $1,500 a month, you would have to live for a long time in order to get back your full $300,000. If you live long enough to make that back, fine, the insurance company will continue to pay your benefit, but if you don't live that long—tough luck.
Of course, there are the surrender charges—you pay hefty fee if you take your money out before you reach 59.5 years old. If you have a lot of money in variable annuities, you could pay a lot in surrender charges. There are also many hidden fees, including sub-account fees, that you could pay, as well as annual fees, administrative charges, mortality charges and expense charges. Some of those fees may be buried in the contract where you have to search to find them and your advisor may not be upfront about either those fees or the commission he is making on the sale.
One of the most attractive features of variable annuities to many investors is the death benefit (usually referred to in sales as the guaranteed benefit). This benefit ensures that if the investor dies before payments are made to him or her, the beneficiary is guaranteed to receive at least the amount of the purchase payments. However, what is usually glossed over in this benefit is that a) the investor must die for this benefit to kick in and b) the payments to the investor cannot have started. Once the payments have started, there is a chance that the beneficiary will not receive that money.
Another negative of variable annuities is that once they become taxable, they are taxed at regular income tax rates, not at capital gains rates, which tend to be the lower of the two rates. So, while the tax-deferred option is nice, the investment must be held for a long time before those benefits are greater than the costs of having the variable annuity.
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It is also not true that there is a guaranteed return on the investor's money because the rate of return is based on the stock, bond and money market sub-accounts that the investor has chosen for his variable annuity. If there are problems with any of those funds, there is a chance the variable annuity will lose money.
If you have been misled about the true benefits of a variable annuity, you may be eligible to file a complaint against your financial advisor and get your money back.