Retirement or Lifetime Income Streams with Variable and Indexed Annuities

By on May 10, 2018

Have you maxed out your annual retirement contributions to your 401k, IRA, or other tax-deferred investment accounts? Are you looking for another tax-deferred investment vehicle? Well, a variable and indexed annuity might help you increase your contributions with a guaranteed stream of retirement income for your future.

Most people think of annuities simply as a steady income stream used by lottery winners or inheritance beneficiaries, but these two annuities are much more! Like most annuities, variable and indexed annuities are an insurance contract which guarantees the policyholder a minimum payment, but each come with their own benefits and drawbacks.

Before you purchase an annuity, consider how each pro and con will work to further or hinder your long-term financial goals. Then pick the type of product which is right for your situation by speaking with a trusted insurance agent or financial advisor.

Immediate and Tax-Deferred Annuities

There are two broad categories of annuities — immediate and tax-deferred. An immediate annuity is the type a lottery winner might choose to distribute their winnings by making a lump-sum deposit which the insurance company pays out on a monthly basis until the policyholder’s death.

A tax-deferred annuity invests the policyholder’s initial deposit allowing it to grow without tax penalties until it is time to be withdrawn; the monthly payment will vary based on the performance of the managed investments. Fixed annuities, variable annuities, equity indexed annuities are types of tax-deferred annuities. We have discussed fixed annuities, so now let us explore the wealth generating possibilities of variable and indexed annuities.

What is a Variable Annuity?

A variable annuity combines the characteristics of a fixed annuity with the benefits of owning mutual funds. The policyholder pays a premium which is used to buy accumulation units that may be invested in select stocks, bonds or mutual-fund accounts. The investments may be changed or rebalanced for the best performance possible, and the money grows tax free in the account until it annuitized for withdrawal.

There are some variable annuity products which have low or no commission fees as well as low expenses and no surrender charges. Depending on your situation (tax liability and how long you expect to live), a variable annuity may be a great savings tool.

The Accumulation and Payout Process

During the accumulation phase, the policyholder contributes money into the annuity with a variety of investment options, ranging from a mutual fund which holds preferred stocks, bonds and/or common stock to money market accounts and international funds.

The money in the investment options will increase or decrease depending on the funds’ performance. Policyholders can work with their insurance company to review the risks, volatility and diversification of the investments in the annuity

Once the policyholder reaches the age of 60 or chooses to begin receiving payments from the fund after retirement, the policy is annuitized into a lump sum or periodic payments for a certain number of years or a lifetime.

For example, say a policyholder puts $300,000 into a variable annuity at age 60 and accept the insurance company’s offer to distribute $1,000 per month for the rest of their life. If the policyholder lives to age 85 they will break even on the contract. If they live beyond age 85, the insurance company must continue to distribute a monthly check, but if they die before reaching age 85, the insurance company keeps the remaining funds.

In addition, the portion of those monthly payments which are considered investment gains are taxed at the policyholder’s income tax rate instead of the long-term capital gains rate. For some this rate could be higher than the current capital gains rate.

For an extra fee, the policyholder can purchase an additional death benefit to guarantee income for beneficiaries. Say the value of the mutual fund accounts in the annuity declines to $250,000; with a normal mutual fund the investor would have lost $50,000, but with a variable annuity and death benefit rider the policy’s beneficiaries would still receive $300,000. If the value of the fund increases, the gains may be “locked in” and the value of the policy is “stepped up” to guarantee the new payout value (measured on a monthly or annual basis).

Key Features of Many Variable Annuities

  • Tax-deferred growth potential of investment portion until withdrawal
  • Low annual annuity costs
  • No surrender charges
  • The ability to invest as much as you want — no IRS contribution limits
  • The ability to control how your assets are invested
  • Optional death benefit rider to lock in market gains or to pass along funds to surviving beneficiaries
  • Optional living income benefit rider guarantees payments even if the account values drops to zero

While variable annuity owners can potentially receive all of the upside of purchasing stocks, bonds and mutual funds, and all of the downside for a possible loss. If you’d be more comfortable with an annuity that guarantees a minimum rate of return or protection against losses on all of the funds in your annuity, you may want to consider a traditional fixed or equity-indexed annuity instead.

What is an Equity-Indexed Annuity?

An equity-indexed annuity is a combination of a fixed and variable annuity with the low-risk appeal of a guaranteed minimum return, but with the possibility to earn higher gains if the stock market rises, since the value of a policy is also tied to the performance of a benchmark index, such as the S&P 500.

An indexed annuity is a contract between the policyholder and an insurance company. The policyholder can choose to make a lump sum payment or a series of premium payments which are used to invest in a certain index. The value of the policy is tied to changes within that index and returns grow tax-deferred until withdrawn. The insurance company will also guarantee you a minimum return (minimums vary from one insurance company to the next).

For example, suppose an indexed annuity is based on the S&P 500, which earns 9% over a year. The terms of the indexed annuity states that fees will be 2.5% and that the maximum cap rate on returns is 6%. The policyholder would receive a total of 4.5% (6% – 2.5%) return from the policy.

Each insurance company may use a different method of calculating returns on a policy. For example, some companies may only account for a portion of the index’s overall return, others may track the index only up to a certain (annual or monthly) cap, and most exclude dividends. If large market returns is what you are after, you may be better off with the mutual funds of a variable annuity.

Key Features of Many Indexed Annuities

Cap Rate

Some indexed annuities have a maximum, or cap, on the amount of index-linked interest the account can accrue each term. In the example given above, if the contract has a 6% cap rate, 6%, and not 9%, would be earned. Not all annuities have a cap rate.

The Floor on Equity Index-Linked Interest

The floor is the minimum interest rate you will earn. The most common floor is 0%. A 0% floor assures that even if the index decreases in value, the index-linked interest that you earn will be zero rather than a negative loss.


In some annuities, the average of an index’s value is used rather than the actual value of the index on a specified date. The index averaging may occur at the beginning, the end, or throughout the entire term of the annuity.


The index-linked interest is based on the difference between the index value at the start and end of the term, typically five to seven years.

Annual Reset

Since the interest earned on the investment is locked in annually by comparing the index value at the end of the contract year with the index value at the start of the contract year. The index value is then “reset” at the end of each year. Any future decreases in the index will not affect the interest you have already earned. Therefore, your annuity using the annual reset method may earn more than annuities using other methods which follow the index fluctuations up and down during the term.

High-Water Mark

Since interest is based on the highest value of the index and the index value at the start of the term, the policy may credit higher interest even if the the index reaches a high point early or in the middle of the term, then drops off at the end of the term. This interest is added to your annuity at the end of the term.

As with most annuities, there are surrender charges and various penalties for terminating or withdrawing from the policy before it comes to term. In some indexed annuities, surrender charges can run as high and last for 15 or more years, so you may not have access to all of your money or lose index-linked interest without paying steep charges.

Speak to a Trusted Broker or Advisor Before You Purchase an Annuity

It is important that you choose an annuity which you understand and is designed to support your personal retirement goals. There are several questions that you should ask yourself and an insurance agent to gain a greater understanding of any annuity you are considering:

  • What is the guaranteed minimum interest rate?
  • What fees, if any, are deducted from my premium or policy value?
  • How long is the term?
  • Does the policy have a cap?
  • Is there a death benefit or living income benefit?
  • Will the policy earnings be vested?
  • Is there a margin, spread, or administrative fee? Is that in addition to or instead of a participation rate?
  • What is the indexing method used?
  • What are the surrender charges associated with terminating the policy early and withdrawing all of my money?
  • What are my annuity payment options?

As with any other insurance product, you must carefully consider your own personal situation and how you feel about the available features. Once you have found an annuity which fits your financial situation and supports your goals for income during retirement, read your contract carefully and review it on an annual basis with your trusted financial advisor.

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About Harold Goldman

I am the founder of, and a Retirement Planning and Long-Term Care specialist. I am also the President of Emes Insurance Services, Inc., a Murrieta based insurance agency designed to help people with Retirement Planning and funding for College. I believe in educating my clients to become financially competent in an effort to develop plans for guaranteed income, protection against loss and tax-advantaged growth. To contact me Call (844)-376-2265

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