Variable Annuities

Understanding Variable Annuities

A variable annuity is a contract with an insurance company that provides periodic payments, either for a specific timeframe or for the entire life of the annuitant. Its defining trait is the investment component active during the accumulation stage—your money is invested in separate accounts tied to the stock or bond markets.

Accumulation Phase: During this stage, premiums are placed in a separate account at the insurance company, exposed to market risk. Unlike the stability offered by a fixed index annuity, variable annuity values can fluctuate daily.

Investment Choices: Policyholders typically direct their premiums among various vehicles, including:

• Stocks: Higher volatility and potentially higher returns, but also greater risk of loss.
• Bonds: Generally more stable than stocks, but still subject to market swings.
• Mutual Funds: Managed portfolios with potential for diversification, yet all tied to the markets.
• Fixed Accounts: Offers a set minimum interest rate, but these are usually a small part of the portfolio.

The Role of Market Risk

Unlike fixed index annuities, variable annuities carry significant market risk. Your account value will fluctuate with investment performance, so:

• Growth Potential: In favorable market conditions, your account value can climb, but there is no principal guarantee.
• Downside Exposure: Poor market returns can reduce your account value, and losses are borne by the contract owner.

Alternatives to Variable Annuities

Minimum Guarantees and Riders

Insurance companies may offer optional riders to soften the impact of market volatility, such as guaranteed minimum income or accumulation benefits. However, these add layers of fees and do not remove the risk of market-driven losses.

• Guaranteed Minimum Income Benefit (GMIB): Ensures a set income level, but fees apply regardless of market performance.
• Guaranteed Minimum Accumulation Benefit (GMAB): Guarantees a minimum account value after a set period, often at a cost.
• Guaranteed Minimum Withdrawal Benefit (GMWB): Secures a minimum withdrawal per year, with added expenses.
• Guaranteed Lifetime Withdrawal Benefit (GLWB): Provides lifetime income, but higher rider costs can impact overall returns.

Before adding riders, carefully review their costs—these extras often contribute to the negative perception of variable annuities and can significantly reduce your growth potential.

Fees and Expenses

Variable annuities are known for their complex fee structures, including:

• Mortality and Expense Risk Charge: Usually 1% to 1.25% per year, just for insurance guarantees.
• Administrative Fees: For recordkeeping and admin, charged as a flat fee or percentage of assets.
• Investment Management Fees: Each investment option carries its own expenses, often similar to mutual funds.
• Surrender Charges: Early withdrawals can trigger substantial penalties, especially in the first years of a contract.

High costs and hidden fees are key reasons why Foxcove Financial prefers fixed index annuities for our clients—FIAs typically avoid these layers of investment and rider charges.

Tax Implications

Like many annuities, variable annuities allow tax-deferred growth—you pay taxes only on distributions. However:

• Ordinary Income Tax: Withdrawals are taxed as regular income, not at capital gains rates.
• Early Withdrawal Penalty: Taking funds before age 59½ incurs a 10% penalty in addition to income taxes.
• Non-Qualified Contracts: If purchased with after-tax money, only the growth is taxed at withdrawal.

Suitability and Considerations

Variable annuities are not the right fit for most conservative retirement savers. Points to weigh:

• Risk Tolerance: If you are uncomfortable with market swings or the chance of losing principal, consider other solutions.
• Time Horizon: These products are designed for long-term goals and can tie up your money for many years.
• Financial Objectives: Match your goals (growth, income, or both) with the product’s features—always compare to lower-risk options.
• Fees: High expenses can undermine potential growth and income.

Working with Foxcove Financial

The complexities and risks of variable annuities mean that Foxcove Financial recommends other principal-protected solutions for most retirement strategies. If you are considering an annuity, Foxcove Financial can help you compare your options and determine whether a fixed index annuity, fixed annuity, or other approach is better aligned with your needs and risk tolerance.

Summary: Fixed Index vs. Variable Annuities

	Fixed Index Annuity (FIA)	Variable Annuity
Principal Protection	✅	❌
Growth Linked to Market Index	✅ (with cap/floor)	✅ (no floor, no cap)
Market Loss Exposure	Protected	At Risk
Typical Annual Fees	Low (or none)	High (1–3%+)
Income Guarantee Options	Available	Available (at extra cost)

Conclusion

While variable annuities may appear attractive due to their market-linked growth, the risks, fees, and lack of principal protection often make them less suitable for secure retirement income planning. Foxcove Financial specializes in fixed index annuities for clients who value guaranteed protection, growth potential, and predictable retirement income—without the complexity and risk of the stock market.