Definition of a Variable Annuity

A variable annuity is a long-term investment product that provides retirement income while allowing the annuitant to invest in various financial markets. Unlike fixed annuities, which offer guaranteed payouts, variable annuities fluctuate in value based on the performance of underlying investment options, such as mutual funds or stocks.

For example, a Canadian investor purchasing a variable annuity can allocate their contributions into different investment funds. If the market performs well, their annuity value and future payouts may increase, but poor market performance can reduce their returns.

Purpose of Variable Annuities in Retirement Planning

Variable annuities serve several financial and retirement planning purposes:

• Tax-Deferred Growth – Investment earnings grow tax-free until withdrawals begin.
• Potential for Higher Returns – Returns depend on market performance, offering growth opportunities.
• Retirement Income Stream – Provides periodic payments, either fixed or variable, during retirement.
• Customization – Investors can choose from various investment options based on risk tolerance.
• Death Benefit Options – Some annuities offer a guaranteed minimum payout to beneficiaries.

How Variable Annuities Work

Investment Contributions

• Investors make either a lump sum payment or regular contributions into their annuity.
• Contributions are allocated to sub-accounts that invest in stocks, bonds, or mutual funds.

Accumulation Phase

• Funds grow tax-deferred during this phase.
• Investment performance determines the annuity’s value.

Payout Phase

• Investors can choose fixed payments or variable withdrawals based on investment performance.
• Payments may fluctuate depending on how the selected investments perform.

Withdrawal and Taxation

• Withdrawals before age 59½ may be subject to penalties.
• In Canada, annuity payouts are partially taxable as they include both principal and investment growth.

Example: A retiree with a variable annuity linked to stock market funds may receive higher payments when the market is strong but lower payments during downturns.

Fixed vs. Variable Annuities

Feature	Fixed Annuity	Variable Annuity
Investment Risk	Low – Guaranteed returns	High – Market-dependent returns
Payout Stability	Predictable payments	Payments fluctuate with investment performance
Growth Potential	Limited by fixed rates	Higher potential for long-term growth
Tax Benefits	Tax-deferred growth	Tax-deferred growth

Example: A risk-averse investor may choose a fixed annuity for guaranteed income, while an investor seeking market-based growth may opt for a variable annuity.

Advantages and Disadvantages of Variable Annuities

Advantages

• Higher growth potential compared to fixed annuities.
• Tax-deferred earnings allow investments to grow without immediate taxation.
• Flexible investment choices tailored to risk tolerance and retirement goals.

Disadvantages

• Market risk may result in lower payouts.
• Higher fees than other investment options, including management and insurance costs.
• Withdrawal restrictions and potential penalties for early withdrawals.

Related Terms

• Fixed annuity – An annuity with stable, guaranteed payouts.
• Deferred annuity – An annuity where payments begin at a later date.
• Guaranteed minimum income benefit (GMIB) – A feature in some variable annuities ensuring a minimum payout.

Interesting Fact

In Canada, variable annuities are often used as retirement income supplements, allowing retirees to benefit from market growth while maintaining tax-deferred earnings.

Statistic

According to the Canadian Life and Health Insurance Association, over 30 percent of retirement annuity products in Canada include variable annuities, highlighting their role in long-term financial planning.

Frequently Asked Questions (FAQ)

1. How does a variable annuity differ from a fixed annuity?

A variable annuity’s payments fluctuate based on investment performance, while a fixed annuity provides guaranteed payouts.

2. Can I lose money with a variable annuity?

Yes, variable annuities are market-dependent, meaning losses are possible if investments perform poorly.

3. Are variable annuities a good retirement investment?

They can be beneficial for long-term investors seeking tax-deferred growth and higher potential returns.

4. What fees are associated with variable annuities?

Variable annuities typically have management fees, administrative fees, and surrender charges for early withdrawals.

5. When can I start withdrawing from a variable annuity?

Withdrawals usually begin at retirement age, but early withdrawals before 59½ may result in penalties.