What’s the difference between a fixed annuity and a variable annuity? Generally speaking fixed annuities are considered to be more conservative. Variable annuities, having the potential for gain and losses, have a higher risk.
Fixed Annuities
Fixed annuities are issued by insurance companies and its security is directly related to the financial strength and claims paying ability of the issuing carrier. In a fixed annuity, the insurance company guarantees you will earn a minimum rate of interest during the time your account is growing. Once the time period is over a new guarantee interest rate is set for the next period. The insurance company also guarantees the periodic payments will be a guaranteed amount per dollar in your account. These periodic payments may last for a definite period, such as 10 years, 20 years or an indefinite period, such as your lifetime or the lifetime of you and your spouse.
Variable Annuities
Variable annuities typically offer a range of funding options from which you may choose. These funding options may include portfolios comprised of stocks, bonds, mutual funds, and money market instruments. The account value of variable annuities can go up or down based on market fluctuations. Your purchase payments and earnings are not guaranteed; instead they depend on the performance of the underlying investment options. If the funding options you choose for your annuity perform well, they may exceed fixed annuity returns If they don’t perform well, you may lose not only any earnings you’ve made, but even some of your actual investment.
Some variable annuities offer, in addition to a range of funding options, a fixed account option that guarantees both principal and interest, much like a fixed annuity. A fixed account option can give you the security of allocating some of your purchase payment more conservatively while still taking advantage of market potential.
Fixed and Variable Annuity Charges/Fees
If you withdraw money from an annuity, there may be a surrender fee or withdrawal charge. Usually surrender charges are applied to all purchase payments you make and can reduce to zero over time. If you save over a longer term, it is possible no surrender charges would apply.
Also, the insurance company will recoup expenses if you choose to surrender your contract early. These are expenses the insurance company could not be realized because you did not leave your money on deposit long enough. Many surrender charges start around 7% to 9% in the first year of a deposit, possibly going to 0% within 7 to 9 years, and may provide for a free corridor (e.g., 10% of the account value) where surrender charges do not apply. Some annuities have surrender charges which are longer and higher than this and you should examine all features of the contract carefully. In addition, a market value adjustment may apply that may be positive or negative.
Surrender fees are usually highest if you take out money in the first few years of an annuity contract. Withdrawals and income payments from annuities are subject to ordinary income taxes. Withdrawals and income payments before age 59 ½ may be subject to a 10% tax penalty (unless an exception applies).
Fixed annuity contract expenses are taken into consideration when the issuing company declares the periodic interest rate or determines the payment amount.
Variable annuities usually have more features and they have, therefore, more complex and higher fees than fixed annuities. For example, variable annuity fees may include an annual contract charge (referred to as a “separate account” charge) which covers administrative expenses and a basic death benefit. In addition, a variable annuity, like many other investments, has fees for the management and operating expenses of the funding options in which your money is invested.
