What Is Variable Annuitization?
Let me explain variable annuitization directly: it's an option in annuities where your income payments fluctuate based on how the investments perform. You choose this during the annuitization phase, when you convert your annuity's accumulated value into regular payments, either guaranteed for life or a set period.
Key Takeaways
- In the accumulation phase, you add funds to the annuity, and earnings grow tax-deferred.
- When you're ready to access the money, you can opt for withdrawals or annuitize the contract.
- Annuitizing means choosing fixed or variable payments; variable ones depend on asset performance.
- Variable annuities offer more profit potential but lower payments in market downturns compared to fixed ones.
Understanding Variable Annuitization
Annuities go through two main phases, and you need to grasp this. First, the accumulation phase: you invest money, and any earnings are tax-deferred, meaning no current income taxes on growth. When you decide to start getting income, options include making withdrawals—either one-off or scheduled—or annuitizing for fixed or variable payments.
In the annuitization phase, if you used after-tax dollars to buy the annuity, each payment has a fixed non-taxable portion as return of your basis, with the rest taxed as income. For withdrawals, all earnings come out taxed first, then the original investment returns tax-free. If it's a pre-tax annuity, like from a retirement account, all income—whether annuitized or withdrawn—is fully taxable as ordinary income.
Variable Annuity Considerations
Deciding on annuity payments can be tough, and it boils down to your risk tolerance versus desired returns. With fixed annuitization, you get the same payment amount every time, no matter the annuity company's portfolio performance. But variable payments change based on an underlying portfolio's results.
FINRA notes that variable annuities are highly complex, with appealing insurance features but accompanied by various fees and charges. You must consider them carefully due to their complication and cost.
Think about how long your funds are committed, potential surrender charges for early withdrawals, commissions sellers receive, risks of value loss, and all associated fees. Annuities offer income security but can tie up money in underperforming products. Sellers get commissions based on the annuity type and value, and variable ones link to sub-accounts similar to mutual funds that you select.
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