A variable annuity resembles a mutual fund, in that it combines a range of investments to spread the risk of any single investment declining in value. But unlike a mutual fund, a variable annuity can make regular payments. And the investor can put money in the annuity by making a single payment or through periodic contributions. Money in a variable annuity is tax-deferred until it is taken out. Most annuities also provide a death benefit, a specific amount that will be paid to heirs.
Study the Prospectus
A variable annuity is regulated by the Securities and Exchange Commission as a form of security bought from an insurance company. It will have a prospectus that explains fees, investment options and other expenses. The prospectus will mention any limits the annuity provider imposes on investments, as well as fees for managing those investments.
A variable annuity has a number of subaccounts or investment portfolios managed by investment professionals. This money can buy common stocks, bonds or money market instruments. Account managers take a long view because annuities usually have 10-year or 15-year terms and there is no need to produce instant profits through frequent trading.
A variable annuity also can have a fixed account. This portion of the money isn't invested in securities whose prices might fluctuate with market conditions. The fixed account is more like a certificate of deposit, earning a fixed rate of interest. Some annuities also have an index feature, with investments tied to a market index to reduce risk.
Risks and Rewards
An annuity holder can choose investments and associated risks. Each subaccount in a variable annuity will have a diversified portfolio of securities based on the objectives: potentially high earnings but with some risk of loss, lower earnings with virtually no risk, or some other combination of risk and earnings potential. All variable annuity subaccounts are subject to market fluctuations unless they are fixed options.
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