Variable Life Insurance: Annuity Or Not?

Variable life insurance and variable annuities are both insurance products that can be used to save for retirement. Variable annuities are a type of insurance product that allows individuals to convert their retirement savings into a guaranteed stream of income payments for life. Variable life insurance, on the other hand, is a type of life insurance policy that offers both a death benefit and a cash value component, with the latter providing the opportunity for tax-deferred growth. While both products offer tax advantages and can be used as part of retirement planning, they serve different purposes and have distinct features.

Variable annuities are a type of insurance product

Variable annuities are often used as a retirement savings product. They can be purchased with either a single upfront payment or a series of payments. The insurance company will then offer a variety of investment options, such as stocks, bonds, or other types of investments. The value of the annuity will depend on the performance of these investments.

Variable annuities have two phases: the accumulation phase and the distribution phase. During the accumulation phase, the annuity is invested in a range of options, and the individual can make additional contributions if they wish. During the distribution phase, the annuity can provide a guaranteed income for life.

Variable annuities also have insurance features. For example, if the annuitant dies before the insurance company starts making payments, many contracts guarantee that the beneficiary will receive a specified amount, usually the amount of the purchase payments made. Variable annuities may also offer additional insurance features, such as promising a certain account value or the ability to make withdrawals for life.

Variable annuities are regulated by various bodies, including state insurance law and the Internal Revenue Code, due to their investment elements. They are also subject to the rules of the Securities Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).

They provide tax-deferral and guaranteed income for life

Variable annuities are a type of insurance product that allows you to build or convert some of your retirement savings into a stream of guaranteed income payments that last for life. They are a great option for those who want to benefit from the potential growth of the stock market and are willing to accept the associated risks.

One of the key advantages of variable annuities is the tax-deferral they offer. This means that you don't have to pay taxes on the income and investment gains from your annuity until you make a withdrawal, receive income payments, or a death benefit is paid. This allows your savings to grow at a faster rate than they would if your gains were taxed immediately, resulting in more savings over time. Additionally, you can transfer funds between different investment options within the variable annuity without incurring federal taxes on the transfers. However, when you do eventually withdraw your money or start receiving annuity payments, your earnings will be taxed as ordinary income.

Variable annuities also provide the benefit of guaranteed income for life. Once you annuitize your savings, you can count on receiving annuity payments for your entire lifetime, even if your other savings are depleted. This feature ensures that you never outlive your retirement income and provides peace of mind during your golden years.

The combination of tax-deferral and guaranteed income for life makes variable annuities an attractive option for individuals looking to secure their financial future and protect their loved ones. However, it is important to carefully consider the risks, fees, and expenses associated with variable annuities before making any investment decisions.

Variable annuities are subject to various fees and charges

Surrender Charges

During the accumulation phase, if you withdraw funds from the annuity before a specified period, usually the first five to ten years, you will incur a surrender charge. This fee is designed to discourage early withdrawals and can be as high as 10% of the withdrawal amount. The surrender charge typically declines gradually over several years, known as the "surrender period."

Mortality and Expense Risk (M&E) Charge

The M&E charge covers the insurance company's cost of providing a guaranteed death benefit and administrative expenses. This fee is usually 1.25% or more per year, calculated as a percentage of your account value.

Administration Fee

The administration fee covers the insurer's ongoing costs for managing your account. It can be charged as a flat account maintenance fee or as a percentage of your account value.

Underlying Fund Expenses

These fees are associated with the management of the sub-accounts or mutual funds in which you invest. They are similar to expense ratios charged by mutual funds and exchange-traded funds (ETFs).

Rider Charges

Variable annuity contracts can include additional features or riders, such as long-term care riders or income riders. These riders come with an extra cost and are often complex, carrying certain risks and limitations.

Sales and Withdrawal Charges

Variable annuities may also include sales and withdrawal charges, which can vary depending on the specific product and provider.

Investment Management Fees

Investment management fees are charged for the management of your investment options within the variable annuity. These fees can impact the growth rate of your savings over time.

Other Fees and Charges

There may be additional fees, such as initial sales loads or charges for transferring funds between investment options. It is important to carefully review the prospectus and understand all the fees associated with a variable annuity before making a decision.

They can be used to protect against market downturns

Variable life insurance is a permanent life insurance policy with an investment component. It is intended to meet certain insurance needs, investment goals, and tax planning objectives. It is a policy that pays a specified amount to your family or others (your beneficiaries) upon your death. It also has a cash value that varies according to the amount of premium you pay, the policy's fees and expenses, and the performance of a menu of investment options—typically mutual funds—offered under the policy.

Variable life insurance policies are considered more volatile than standard life insurance policies. The cash value component of variable life insurance is invested in assets like mutual funds, so it may rise or fall in value. This means that these policies carry more risk compared to other life insurance policies.

However, there are ways to protect against market downturns and reduce the overall risk of variable life insurance policies. Firstly, you can allocate a portion of your premium to a fixed account, which guarantees a rate of return. This rate may change annually but typically has a guaranteed minimum, such as 3%. By doing so, you can balance out the riskier investments with a more stable option.

Another way to protect against market downturns is to carefully consider the investment options available to you. Variable life insurance policies usually offer a range of investment choices, including mutual funds, index funds, equities, bonds, or money market funds. By diversifying your investments and choosing options that align with your risk tolerance and financial goals, you can mitigate the impact of market downturns.

Additionally, some variable life insurance policies offer optional riders or benefits that can help protect your savings from losing value. These riders may ensure that your principal contributions are protected, even if the market declines. While there is usually a charge for this extra protection, it can provide added security during volatile market conditions.

Furthermore, the tax advantages of variable life insurance can also help protect against market downturns. The growth of the cash value account is typically tax-deferred, which means you will only be taxed when you withdraw money from your policy. This allows your savings to grow at a faster rate, as you don't have to account for taxes during the accumulation phase.

Finally, it is important to consult a financial advisor or tax professional before investing in a variable life insurance policy. They can help you understand the risks involved, assess your financial situation, and determine if this type of policy is suitable for your needs. By seeking expert advice, you can make informed decisions that align with your risk tolerance and financial goals, ultimately helping to protect against market downturns.

Variable annuities are regulated by the SEC

Variable annuities are a leading source of investor complaints to FINRA due to their complexity and confusion, which can lead to questionable sales practices. FINRA has developed rules to enhance firms' compliance and supervisory systems and provide more comprehensive and targeted protection to investors who purchase or exchange deferred variable annuities. These rules include requirements for registered representatives to reasonably believe that customers have been informed of the various features of annuities, such as surrender charges, potential tax penalties, fees, costs, and market risk.

The SEC also provides information on the key risks associated with variable annuity contracts, such as the death benefit and other insurance features, fees and expenses, and the process of exchanging one variable annuity for another. It is important for investors to understand these risks and regulations before investing in variable annuities.

Frequently asked questions