Variable Annuities: Investment Performance Based on Portfolios Chosen by the Owner
With a variable annuity, contract owners are able to choose from a wide range of investment options called subaccounts, each of which generally invests in shares of a single underlying mutual fund or, in some cases, in a “fund of funds,” which is a mutual fund that invests in several other mutual funds or in exchange-traded funds (ETFs). Variable annuity contract owners are able to direct the allocation of their contract value among subaccounts that correspond to a wide range of underlying mutual funds, such as equity funds, bond funds, funds that combine equities and bonds, actively managed funds, index funds, domestic funds, and international funds. Unlike mutual funds sold to the public, the mutual funds that underlie subaccounts are available only to investors in variable annuities, variable life insurance contracts, and in some cases, 401(k) plans, IRAs, and certain other investors permitted by applicable tax laws and regulations. Assets in a variable annuity can be transferred between subaccounts tax free. As a result, investment decisions can be made based on an investor’s needs and strategy without worrying about the tax implications.
As with mutual funds, the investment return of variable annuities fluctuates. During the accumulation phase, the contract value varies based on the performance of the underlying subaccounts chosen. During the payout phase of a deferred variable annuity (and throughout the entire life of an immediate variable annuity), the dollar amount of the annuity payments may fluctuate, again based on how the portfolio performs.
Unlike mutual funds, annuities offer a wide variety of guarantees to protect a contract owner’s investment. Death benefits provide principal protection in the event a contract owner dies during a market downturn. Living benefit features protect against investment and/or longevity risk by providing guarantees that cover income, accumulation, and withdrawals for either a fixed number of years or for life.
In addition to variable investment options or subaccounts, many variable annuities offer a fixed account or fixed investment option. This means that during the accumulation phase of a deferred variable annuity, the owner can allocate payments not only to one or more variable investment options, but to a fixed interest option as well. The money allocated to the fixed option goes into the insurance company’s general account. A minimum rate of interest is typically guaranteed for a period of one or more years.
During the payout phase of some contracts, only fixed annuity income payments are offered. Other contracts provide fixed and/or variable payouts. Providing both types of payouts allows contract owners to take on the added risk associated with variable investment options while accumulating assets, and to manage their level of risk during retirement by choosing to have the rate of return guaranteed for at least some portion of their income payments.