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ANNUITIES: THE GOOD, THE BAD, AND THE UGLY

What Is An Annuity?

I get asked this question all the time. In simple terms an annuity is simply an investment contract between you and an insurance company.

Annuities are most commonly purchased to provide retirement income either starting right away, or at set to begin at some future date.

Annuities are designed to help to protect a portion of your retirement savings. They can protect you from losses in the market, Generate guaranteed interest, Provide guaranteed death benefits for your beneficiaries, Or a guaranteed income that can last for the rest of your life.

Think of it like this. You probably already have different kinds of insurance to protect your assets in the case of a catastrophic loss.

Homeowners insurance, in case of a fire or a flood
Life Insurance, to provide money for your family if you pass away early
Car Insurance, and Health Insurance.

So just like an insurance company can protect your other assets, an annuity is designed to protect another one of your valuable assets, your retirement.

Consider this…

Since 1980 the S&P 500 has had a 10% or greater correction about once every 2 years.

While you’re still working and making regular contributions to retirement accounts like your 401k, these market corrections may actually work in your favor, because you’re able to buy more shares of your investments at lower prices. This is the Accumulation Phase of your Retirement Plan.

When you retire and begin living off of some of your investments you enter the Retirement Withdrawal Phase. Here, these market corrections, compound and work against you, because not only are you probably not adding to these investments anymore, but you may also be selling them to meet your retirement lifestyle expenses.

Most of us probably remember the Dot Com Bubble that peaked in March 2000. After finally bottoming in March of 2003 the S&P 500 had lost nearly half of its value. (-48%)

It took nearly 5 years for the value of the S&P to get back up to those same levels in late 2007 and just as it got back to even, the Great Financial Crises was underway. When the bottom was reached in March of 2009, the S&P had lost 57% of its value. It was almost another 5 years before the S&P 500 reached a new high.

For nearly 13 years the Stock Market went sideways with two major crashes. If you know anyone who retired around that time they would probably have some stories to tell about just how challenging a time that was. I’m sure there are some who never fully recovered.

As you get closer to retirement, most of us will want to begin shifting to a more conservative portfolio. Fewer years to work and contribute to investment accounts leaves you with less time to be able to recover from any market downturn, but a major market correction could literally destroy your retirement.

Annuities can be purchased inside an IRA, or they can be purchased outside an IRA.

One benefit of annuities is that they generally grow tax deferred. Which means you don’t pay any taxes until you actually take your money out. And, there are no IRS limits as to how much you can put into an annuity, so for some people it can be a great way to get additional dollars invested in a tax deferred vehicle after you have already maxed out your IRA and 401k.

Because annuities are meant to be long term investments designed for retirement, there may be fees or penalties for taking your money out early. However, most annuities will allow you to take an annual free withdrawal amount, usually 10% of your initial investment. If your annuity has a guaranteed income or withdrawal benefit, most annuities will allow you to turn that on, even before the surrender period ends

Keep in mind though, just like money in your IRA or 401k, withdrawals taken before 59 1/2 are subject to a 10% penalty in addition to any surrender charges that also may apply.

Because annuities are tax- deferred, any gains you withdrawal are taxed as ordinary income.

Are Annuities Like A Pension?

Even if you’re not familiar with annuities, chances are, you are probably at least somewhat familiar with another form of guaranteed income for retirement, The Employer Sponsored Pension.

As recently as 1990, 50% to 60% of U.S. Workers were covered by an employer sponsored pension. Today, only about 19% of workers are covered.

For many retirees a guaranteed predictable stream of income from a pension became a key piece of a 3 legged stool, that includes Social Security, Pension and Retirement Savings.

Image of stool from keynote.

For those that have a pension, the idea of it being an investment, may not have occurred to them, because they probably were never given the choice. They either had a pension or they didn’t.

In 2012, General Motors, with the largest private pension plan in the world, decided to offer a “buy out” for approximately $25 Billion of their total pension plan assets. If you were one of these participants you were presented an offer to either continue on with the monthly pension checks, or trade that for a lump sum of cash.

Working here in the Metro Detroit area, we worked with many participants who received this offer. And, it was a big offer. Depending on age, time with the company etc. The offer was typically well above the six figure mark and many were over $1 million.

For the first time, these pension participants needed to evaluate their pension as an investment. Take a pile of cash or a regular guaranteed stream of income guaranteed for life. There is a lot of planning and evaluation that goes into a decision like that.

Taking the lump sum meant that they would now be responsible for investing this money and taking on all of the risk associated with that. Dealing with market corrections and managing the investment for any withdrawals needed to cover retirement living expenses.

For us, as we helped our clients with that decision, it really became a matter of how much risk someone wanted to take and how important that stream of income was to their retirement success. If that income was a key component to covering their basic retirement needs then most often we probably opted to keep the monthly pension.

So, for those of us that don’t have a pension, we can think this the same way, only in reverse. Trade a portion of our retirement savings for a guaranteed, predictable stream of income, similar to that of a pension. Thats what were going to be discussing here.

By the way, for the participants that elected to keep the monthly pension. They would no longer be receiving checks from the General Motors Pension Plan. GM sold those assets to one of the largest annuity insurance companies, Prudential Financial. After the buyout expiration, not only would their checks come from Prudential, but the backing of those checks was no longer the GM Pension Plan, it was backed by the full faith and credit of Prudential Financial.

The 4 Basic Types Of Annuities

There are pros and cons to each type of annuity. Before you invest in any annuity, make sure you fully understand all the facts, how specifically it works, what costs are involved and how long your money may locked up for.

Immediate annuities
Fixed annuities
Index annuities
Variable annuities

Any Guarantees are backed by the Insurance Company that issued the Annuity

It is also very important to research the credit quality of the insurance company that is issuing the annuity. You want to stay with A rated companies or better. Remember, even though annuities are issued through insurance companies, they are not FDIC insured the way that bank accounts and CD’s are.

1. Immediate Annuities

An immediate annuity is kind of like a pension that you fund yourself. Its generally considered the most traditional type of annuity. Basically you give an insurance company a lump sum of money, and in return they give you a regular stream of income, usually guaranteed for the rest of your life.

Now, when you give the money to the insurance company you pretty much lose control of your money, which is one of the biggest disadvantages of this type of annuity.

The amount of income you get is going to be based on a number of factors.

Primarily these are:

The amount you invest, (obviously the more money you put in the larger your annuity payments will be)
The interest rate environment at the time you purchase your policy (Generally the higher interest rates are at the time you buy your annuity, the higher your income payments will be.)
The age and gender of the people the policy covers. The older you are the more money you will get.
The Payout option you select. (I’ll cover this more later.)
When your payments begin, and how often you receive them (whether its monthly quarterly, annually etc.)

To give you a better idea of how these immediate annuities work, lets look at a few examples.

Hypothetical example 65 year old couple, Immediate Income. Example based on a SPIA quote from a high quality Insurance Company July 2024

$300,000 One Time Premium

100% Income Continuation for surviving spouse

$1650 per month

Joint Life

Basic Joint Life Annuity:

This is an example of a basic joint life annuity payment option. The disadvantage of this is, lets say that something happens to both of you after receiving only 2 years worth of income. So you would have collected $39,600 in income. With this option the income just stops. and the insurance company keeps the rest of your money. In this case $260,400.

Even though the probability may be low, this scenario is not ideal. So for a relatively small amount of money you can add an option that guarantees you or your beneficiaries to get back at least, your initial premium.

Continuing with this example, adding something called a cash refund option, would guarantee that any portion of the initial premium not yet paid out through the monthly income payments, would be paid out as a one time refund to the beneficiaries.

In our example adding the Cash Refund Option would reduce the monthly income from $1650 to $1635. Just $15 per month.

Other Income Options that you may be able to choose from

Period Certain Options:

In addition to choosing joint income and potentially a cash refund option, you could also add on a period certain option. Like the name suggests, this is an additional guarantee you can add on to your policy that guarantees at least a certain number of payments. Even if the primary individuals receiving lifetime income both pass away. This period certain can be for 5, 10, 15, 20 or even 30 years.

So lets go back to our example. If you had bought this same annuity with the 30 year period certain option, instead of getting $1635, per month, you would get $1525 per month. About $110 less per month.

However, In our example where we had the premature deaths, and the income just stopped. With the 30 year period certain option, your beneficiaries are going to continue to receive 28 more years of regular monthly income checks. So effectively this option is guaranteeing at least $549,000 of payments over a 30 year year period. If you or your joint income partner live longer than 30 years, the income keeps going and you get more, but it can’t pay less.

If your going to invest in an immediate annuity, I would strongly suggest looking at these period certain options. The difference in payments generally are not that great. And its a great way to ensure that at least you, or your beneficiaries will get a minimum amount of return from your investment.

The Deferred Income Annuity

What We’ve been discussing so far in this section refers to a Single Premium Immediate Annuity. You invest money, then immediately begin receiving payments. But what if you don’t need the money right away?

The Deferred Income Annuity allows you to buy into the annuity with a single payment or a predetermined sequence of payments, then begin taking income at a pre determined time in the future. Notice the word pre-determined. These contracts are not very flexible.

Let’s take a quick look at another Hypothetical example.

Here we’ll use a 60 year old couple, and instead of taking income immediately, they plan to defer the income for 5 years. Example based on a SPIA quote from a high quality Insurance Company July 2024

$300,000 One Time Premium

Delay taking income for 5 years

100% Income Continuation for surviving spouse

Joint Life

$2200 per month

Both this example and the earlier one had income payments beginning at age 65. The difference in this second one is the 5 years of deferral. It did however make a significant difference for the monthly income, raising it $550 per month.

SPIA/DIA Wrap Up

So to wrap up. Obviously there are a lot of options, and things to consider before investing in any annuity, here are some of the advantages and disadvantages of immediate annuities.

Immediate annuity advantages:

Lifetime income (One of the biggest advantages of these immediate annuities, is that they create an income that you cant outlive)
Joint income can cover non spouses, Most other annuities only offer joint income payments for spouses.
The annuity Exclusion ratio. One of the unique benefits of immediate annuities is something called the annuity exclusion ratio. According to an IRS formula, a portion of each one of your annuity checks will be free from income taxes. Usually if you are starting an immediate annuity over the age of 60, as much as 70 – 80 % of your payment could be tax free. Its important to note that this tax free portion is only for money you invest in non retirement accounts. If you own an immediate annuity in an IRA, usually 100% of the payments you receive will be taxable. If you were to own one of these annuities inside a Roth IRA, you would have all of your income tax free.
When interest rates are high they could be a great way to generate long term retirement income and take advantage of the high rates.

* For your specific situation, you should consult your tax advisor.

Disadvantages

Dying prematurely, can drastically effect the amount of income that gets paid out from the annuity. Depending on which payout option you selected.
Most annuities generally don’t keep up with inflation. and adding an inflation rider can be expensive.
Once you invest in an immediate annuity, you generally lose control of your money. you don’t usually have any access to your money, in case of an emergency, and you cant change your income or payout option once you elect it.
When interest rates are low, there may be better alternatives for creating long term retirement income.
SPIA/DIA tend not to be flexible.
Current rates on SPIA/DIA compared to other annuity options such as a Fixed Index Annuity are not that much higher.

* Riders are additional guarantee options that are available to an annuity or life insurance contract holder. While some riders are part of an existing contract, many others may carry additional fees, charges and restrictions, and the policy holder should review their contract carefully before purchasing.

2. Fixed Annuities and Multi Year Guaranteed Annuities (MYGAs)

The second type of annuity is called a fixed annuity. Fixed annuities are generally pretty simple. Similar to a CD or a bond, you get a fixed rate of interest for a specific period of time. The kind of rates you can expect will usually be slightly higher than the rates you would get on a CD for the same length of time. So typically, just like a CD, you’re going to get a higher rate of interest the longer you go out.

CD’s are FDIC insured and offer a fixed rate of return if held to maturity.

Here are a couple of things to keep in mind…

All Annuities are Retirement Savings Vehicles

First, just like all other annuities, these are primarily intended as retirement savings vehicles. So they grow tax deferred. Which can be an advantage for some people. However, you need to remember that because of this tax deferral, you generally can’t touch the money until you’re at least 59 1/2. If you do, any interest or value above your initial premium would likely be subject to a 10% penalty in addition to your regular taxes.

Fixed Annuities Generally fall into 2 Broad Categories.

Traditional Fixed Annuities and Multi-Year Guaranteed Annuities

Traditional Fixed Annuities

Provide a guaranteed interest rate for a specific period of time. After the initial period ends, the interest rate can change based on the prevailing interest rate environment.

Just like with other annuities you may be locked into a surrender period that can penalize you for taking your money out early.

Most traditional fixed annuities offer a minimum rate of interest, but it tends to be low. Possibly something like a 1% minimum rate.

Because, the interest rates can change after the initial period, and the minimum interest rates tend to be low, these annuities are not nearly as popular as they once were.

Multi-Year Guaranteed Annuities (MYGA)

MYGAs are actually a type of fixed annuity. The primary difference with a MYGA is that the interest rate is fixed for the entire duration of the contract.

MYGA’s have a fixed maturity. Typically ranging from 1 to 10 years in duration. Normally, you would expect to get more interest the longer you go out in duration. I say normally, because as I write this in July of 2024, the yield curve is inverted. Which means that shorter maturities actually pay a little more than longer term contracts.

When the MYGA matures you are free to do whatever you want with the money and the interest you’ve earned. Roll it back into another MYGA, cash it out etc.

Remember, just like with all annuities any gains or interest may be subject to an IRS 10% pre mature withdrawal penalty for taking it out before you reach 59 1/2.

You will also pay taxes on any gains or interest at your ordinary income tax rate.

Annuities are Not FDIC Insured

Fixed annuities are not FDIC insured, so it is very important to look at the credit worthiness of the underlying insurance company. Fixed annuities are however, very heavily regulated. They are required to keep dollar for dollar of their deposits in reserves, invested in a very high quality bond portfolio. They are also required to have reinsurance on the portfolio as well.

3. Fixed Index Annuities (FIAs)

The Third type of annuity is called an Index Annuity. Also called a Fixed Index Annuity, because its actually a form of a Fixed Annuity.

The biggest difference of an Index Annuity vs. a Regular Fixed Annuity is how you earn interest on your account.

How a Fixed Index Annuity Works

With an FIA, interest is credited to your account based on participation in an index, such as the Standard & Poor’s 500, the NASDAQ etc. You may also see indexes created by large financial institutions such as Blackrock, Franklin or Bloomberg.

Most commonly, interest is credited using a “Point to Point” method.

This works by using the price change on the index you choose from one point in time to another. Most often this is annually.

Here’s a quick example…

Let’s say you purchase an annuity and the effective date is August 15, 2024 and you choose the S&P 500 as your Index. Using an annual point to point method, a snapshot is taken to capture the starting value of the index. Exactly one year later, on August 15 2025 a second snapshot is taken to get the value of the index. If the index is higher, some interest may be applied to your account, depending on participation. (More on this later).

However, if the return of the index was negative, you just get a zero for the interest for that period.

Again, annual point to point is what we see most common with these annuities, but sometimes its a two year point to point or something else.

The two year point to point works exactly the same way except the second snapshot is taken at the two year mark instead of at the end of year one.

Often the two year point to point will have a greater amount of participation in the index, but two years could be a disadvantage. Let’s say in year one, the index is negative, now you need to dig your way out of a hole in year two just to get back to positive. The opposite could also happen. A good year one return, then the market tanks in year two erasing your gains. With the annual point to point, you start fresh every year. Potentially locking in a gain or reseting back to zero.

One other quick note. The price change for the index does not include dividends just the price change.

Participation in the Index

Sounds like a pretty good deal. I make interest when the market goes up, but if the market goes down, I just get a zero for that period.

Well, there is a slight catch. In exchange for eliminating negative returns, there will be some limitations as to how much of the return on that index is actually applied to your account.

There are 3 primary ways that your annuity could limit how much interest gets credited to your account each year.

The first way is through a cap or a ceiling Which basically means they limit you as to how much interest you can earn in any given year.

As an example, you may see a cap on the S&P 500 set at 5%. This means that you will get the price change return of the S&P 500 up to a maximum of 5%. If the index goes up 3%, you get 3%, but if the market goes down 11%, you get 0%. Remember, your principle is always protected.

The second way is through a spread. The spread is an amount that is subtracted from the return of the index each year. So if the index went up by 12% and you had a spread of 4%, your return would be 8%. again if the index is negative, you just get 0% for the year.

The third way is through a participation rate. This is a percentage of how much you participate in the performance of the index. So if your participation rate is 80%, and the index was up 10% for the year. Your return would be 8%. or simply 80% of the 10%., And again if the index is negative you just get zero.

Sometimes, depending on the index, you could actually see a participation rate greater than 100%. So if your participation rate was 120% and the index returned 10% you would actually be credited 12%.

It is very important to know what the limitations to return are and how they work. Different companies and indexes will use different methods. You could even see all 3 crediting options on different indexes even within the same annuity!

FIA Caps, Spreads and Participation Rates can change from contract year to contact year.

Most annuities will also offer a guaranteed interest account. Here, interest is set at the beginning of the contract and subject to change every year on the contract anniversary.

What we’ve been discussing so far is the basics of how an index annuity works, how you can earn interest and how your principal is always protected. These basic index annuities do exist without any other bells and whistles or guaranteed withdrawal options. Usually with out any fees.

The FIA Guaranteed Withdrawal Benefit

For those that want to use their annuity for a predictable stream of income, you may be able to add a guaranteed withdrawal benefit to the contract, or with some, it comes automatically. Always with a fee. Typically 1% to 1.5% per year.

The FIA Guaranteed Withdrawal Benefit is designed to provide a guaranteed income or withdrawal for the rest of your life and possibly for a joint lifetime with your spouse if you choose.

The amount of income you receive will be based on a few key factors.

1. Obviously the amount of money you invest in the annuity will be the primary factor for how much you receive in income. The more you put in, the more guaranteed income you will receive.

2. Depending on the annuity your age at the time the annuity is issued will be important. Basically the older you are the higher your guaranteed income, because your remaining life expectancy is less.

3. Electing a joint lifetime income will reduce the amount of income you get because they are insuring two lives instead of just one. Also, the age of your spouse will also be considered. Typically FIA’s are based on the age of the younger spouse.

4. With an FIA, you could elect to receive income right away, but many will choose to defer taking income for some period of time. The longer you defer taking income the more your guaranteed income will increase. Most FIA contracts have a predetermined rate of increase so you know how much you income you would get for every year that you wait to take your income.

5. The default option for most FIA’s is a fixed guaranteed income for life.(Joint life) Some offer a rising income opportunity as a way to help keep pace with inflation. They all work a bit differently, so make sure you fully understand how it works before electing this option. If you do choose a rising income option, you typically start off with a lower amount of income. The hope is that the income will eventually rise to a level that would be greater than the fixed income option. There usually is no guarantee that this will happen, or that you would get any increases to your income. Its usually dependent on the return and participation in the index.

FIA Guaranteed Withdrawal Hypothetical Example

As mentioned earlier your Guaranteed Withdrawal will be based primarily on the age when you buy the annuity, Joint or Single Life, and choosing a fixed or rising income option.

Your guaranteed withdrawal amount might be based off of a table similar to the one shown below. Unless you’re choosing to begin taking withdrawals right away, you probably wont have to decide when to turn on your income, or to make it single or joint or go with the rising income option. All of that is usually decided at the time you elect to turn on your withdrawals.

Age at Purchase	Single	Joint
58	6%	5.5%
59	6.1%	5.6%
60	6.2%	5.7%
61	6.3%	5.8%
62	6.4%	5.9%
63	6.5%	6.0%
64	6.6%	6.1%
65	6.7%	6.2%

What if you don’t want or need to take the income right away?

You could wait to buy an annuity until the time that you need to begin taking withdrawals, but many people will want to set this up in advance as they shift their portfolio to create their retirement income plan.

When you defer taking withdrawals from your annuity two things may happen.

You will potentially earn interest based on the crediting strategy and participation in the index you choose.
Most Fixed Index Annuities increase your withdrawal percentage for every year of deferral.

So, continuing with our example above, lets say the annuity has a .5% increase for every year of deferral. This would be added to the beginning withdrawal rate from the table above, and depending on the options you elect.

To keep things simple, if you were to delay taking withdrawals for 4 years you would get 2% added to the withdrawal rate. (4x.5=2)

If the younger spouse was 61 at the time of purchase, the beginning withdrawal rate would be 5.8%, and after 4 years of deferral that withdrawal percentage would increase to 7.8%

What is the Guaranteed Withdrawal Rate Based on?

Hopefully now, you understand how the withdrawal rates work based on options you select and potentially increase based on waiting to take income.

The next question is what is the withdrawal rate based on. Most annuities will apply the withdrawal rate to the greater of the initial premium that you invest in the annuity or the accumulation value.

The accumulation value would be based on any interest credits you earn, less any fees that may apply or any withdrawals taken.

Now lets apply some numbers to our example

If our hypothetical clients age 63 and 61 invest $500,000 into our annuity example, they could turn on a guaranteed joint lifetime income right away of $29,000 per year. As long as they don’t take more than that amount, that income would continue for as long as either one of them are alive. ($500,000 x 5.8% = $29,000)

If they decided to delay taking withdrawals for 4 years and add .5% to the withdrawal rate for every year of deferral, they would get $39,000. Again guaranteed for as long as either one of them are alive. ($500,000 x 7.8% = $39,000)

If the annuity were able to earn some interest credits along the way, then the withdrawal percentage would be applied to the accumulation value.

For our example, lets say the accumulation value was $550,000 at the end of 4 years at the time they want to turn on income. (This is a little less than 3% growth per year after fees). The guaranteed income in this example would be $42,900. ($550,000 x 7.8% = $42,900)

When evaluating annuities, always plan around the minimum guarantees, which in this case is $39,000.

4. Variable Annuities (VAs)

The 4th type of annuity is called a variable annuity.

Just like all annuities, variable annuities are issued through insurance companies and grow tax deferred.

A Variable annuity is basically an annuity that allows you to buy mutual funds in it.

Mutual funds inside annuities are called sub accounts. And just like mutual funds, these sub accounts can be invested in all kinds of things. Stocks, bonds, international investments etc. Some can be conservative, and some can be very aggressive.

Variable Annuity for Tax Deferred Growth

Like all annuities variable annuities fall into the tax deferred retirement account category, and this can be a reason that some people are attracted to them.

Money contributed to an annuity always goes in after tax and any growth or interest is tax deferred. When you withdrawal the money it gets taxed as ordinary income. Taxes are paid on any withdrawals until you reach your original investment, then distributions are treated as a non taxable return of principal.

Just like all retirement accounts, distributions before age 59 1/2 would likely be subject to a 10% penalty in addition to any taxes owed.

While the advantage of deferring taxes in an annuity could sound appealing, I would only recommend buying one after you’ve already maxed out other tax deferred retirement accounts such as 401k, IRA or Roth IRA Accounts.

Variable Annuities not as Popular

In recent years variable annuities have fallen in popularity and many insurance companies have reduced their offerings in this category.

One reason for this could be fees. Often when you hear about high fees on annuities, its probably in reference to variable annuities.

Variable Annuity Investing in Sub Accounts

With variable annuities your money is invested in sub accounts which are similar to mutual funds. Depending on the performance of those funds, they can go up and down just like any other mutual fund type of investment. Depending on what the funds are invested in they can even go down a lot. So there are never any guarantees that you will make money on these investments.

Variable annuities typically have a menu of investment options that could range from a couple of dozen to well over 100 options. Because variable annuities often have a surrender period that could last for 7 years or longer, you will want to research the investment menu to make sure you like the choices.

Within the menu of options you usually can move money between investments however you want. The advantage of the annuity is that even if you have a gain when you sell one of these sub account investments you don’t actually have to pay taxes until you withdrawal the money from the annuity.

Variable Annuity Guaranteed Withdrawal Benefits

Another reason a variable annuity could be considered is for some of the other guarantees that an annuity could provide that a regular mutual fund cannot. Similar to other types of annuities, variable annuities can also guarantee income for life.

As you invest in your portfolio of sub accounts the performance of these funds will be unknown and largely dependent on how the markets are doing and how well you are able to choose the investment sub accounts.

Regardless as to how your sub accounts do, the annuity company may provide a predictable rate of growth on something they call your benefit base. Usually at a rate ranging from 5% to 8% per year.

Periodic Lock ins:

Additionally some annuity companies may periodically lock in the value of your benefit base, based on the value of your sub account portfolio. Most of the time this is done quarterly, but some companies will do it annually.

Withdrawal Phase:

With a Guaranteed Minimum withdrawal Benefit, Depending on when you begin taking withdrawals, the annuity company will guarantee withdrawals based on your benefit base, even if it is substantially higher than your actual account value.

An example of a withdrawal schedule might look something like this:

Withdrawals begin at age 60 you might get a 4% guaranteed withdrawal rate.
If you wait till age 65 you might get 4.5%-5%,
and if wait until your 80 you could get as much as 5.5%

Just like other annuities, variable annuities also allow you to guarantee a joint lifetime income with your spouse. If you elect joint income, typically you would see your withdrawal percentage reduced by about 1/2 percent or so.

Death Benefits:

Death benefit options will pay out a lump sum to your beneficiaries when you die. Your beneficiaries are always able to take your account value as a lump sum with no surrender charges. But by adding a death benefit rider your beneficiaries could get more than your account value.

Other Considerations on Variable Annuities:

Your money may be locked up, for a period of time. Most of these Variable annuities will have limits as to how much of your money you can withdrawal each year. This may vary from one annuity to the next, but typically you see these withdrawal limitations lasting from 4-10 years.

Free Withdrawals

Just like with other types of annuities variable annuities will also give you some access to your money even within the initial surrender period.

Usually this is 10% of your original investment.

So lets say you recently invested $100,000 in a variable annuity that had a 10% free withdrawal amount. Under this provision, you would have access to 10% of your original investment, or, in this case $10,000. You could take this 10% out every year if you wanted during the surrender period.

If you exceed the free withdrawal amount, you will be assessed an early withdrawal penalty on just the amount over the free withdrawal. Usually something like this…

8% for taking withdrawals in year 1

7% for taking withdrawals in year 2

6% for taking withdrawals in year 3

5% for taking withdrawals in year 4

4% for taking withdrawals in year 5

3% for taking withdrawals in year 6

2% for taking withdrawals in year 7

What this means is that your early withdrawal penalty would be 8% in the first year, 7% in the second year, and so on.

So lets say in year 4 you need to withdrawal $15,000. The first $10,000 would be free, but you would get hit with a 5% surrender charge on $5,000. The amount you exceeded the free withdrawal by.

So 5% of $5,000 means you would have a $250 penalty on your withdrawal.

Variable Annuity Costs:

As mentioned earlier, variable annuities can be known for having high fees and expenses. These can be broken down into 3 categories

The base costs associated with a variable annuity, sometimes called Mortality and Expense (M&E) charge. This is usually about 1.5% Some are going to be a little higher, some a little lower, but the average is going to be around 1.5%

(Annuities with shorter surrender schedules will usually have higher internal costs. Also if you buy an annuity with a bonus, you will likely have higher costs as well as, a longer surrender schedule.)

Cost of any riders such as a guaranteed withdrawal benefit or a death benefit.

This can vary depending on the rider and the company, but on average these can range from about 1% to 1.5%

Cost of the mutual fund sub accounts. Just like any mutual funds, annuity sub accounts have fees, to cover the management and administration of the funds. Usually this is about 1%, pretty much the same as it is for many mutual funds.

In total it would not be uncommon at all to have all in fees greater than 3% per year and some even go over 4%

VA Recap

So to recap variable annuities:

They are similar to investing in mutual funds, where your performance will be dependent on how your mutual fund sub accounts do.
Variable annuities can provide guaranteed growth of a benefit base, that can be used to provide retirement income that is guaranteed for life or joint life
In return for the guarantees and protections, Variable annuities generally charge more than mutual funds.
Variable annuities are not guaranteed, or FDIC insured, so even though you might have a protected benefit base that could be higher, if you cash out you will only get the actual value of your account.

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