Variable Annuitization is an annuity option in which the amount of the income payments received by the policyholder will vary according to the investment performance of the annuity. Variable annuitization can be selected by the policyholder during the annuitization phase of a contract, which is when the accumulated value of the annuity is exchanged for a stream of regular income payments guaranteed for life or specified term.
Key Takeaways
- During the accumulation phase of an annuity, an investor adds funds, and the earnings grow tax-deferred.
- When the policyholder is ready to start receiving payouts, they can choose to withdraw funds or annuitize the contract.
- If the policyholder chooses to annuitize, they have the option to select either fixed or variable payments.
- Variable annuities fluctuate in value based on the performance of the underlying assets.
- There is potential for higher profits with variable annuities, but payments may be lower during market downturns compared to fixed annuities.
Insights Into Variable Annuitization
The Two Phases of Annuities
An annuity has two main phases: the accumulation phase and the annuitization phase. During the accumulation phase, an investor contributes to the annuity, with earnings accumulating tax-deferred. Once the policyholder decides to start receiving income, they can either withdraw the funds or annuitize the contract. If they choose to annuitize, they select between fixed and variable payment options.
Tax Implications
For annuities purchased with after-tax dollars:
- During annuitization, a portion of each payment is a non-taxable return of the original investment, with the balance taxed as ordinary income.
- Withdrawals are taxed as ordinary income until all earnings are depleted, after which withdrawals are a return of the principal.
For annuities purchased with pre-tax dollars:
- All payouts, whether through annuitization or withdrawals, are taxed as ordinary income.
Important Considerations for Variable Annuities
Choosing the method of receiving payments from an annuity largely depends on the policyholder’s risk tolerance and return expectations. Opting for fixed annuitization guarantees a consistent income, irrespective of market conditions. In contrast, variable annuitization entails variable payments reflective of the performance of the annuity’s portfolio.
Financial regulators indicate that while variable annuities are complex, they offer insurance features that might be enticing but come with various fees and charges. Such investments require careful deliberation, especially concerning lock-in periods, penalties for early withdrawal, potential commission benefits to sellers, and overall fees and expenses.
Additional Factors to Consider
Purchasing an annuity allows for income security but commits funds to a product that may underperform. Sellers typically earn commissions based on the annuity type and value. The valuation of variable annuities is connected to the performance of mutual fund-like investments called sub-accounts that the annuity owner selects.
Ultimately, understanding the nuances between fixed and variable annuitization helps with making informed decisions that align with long-term financial goals.
Related Terms: annuity, accumulation phase, annuitization, fixed annuitization, variable annuity.
