Fixed vs. Variable Annuities- Comparing Returns, Features, and Risks

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byNikhil Bhauwala

Fri Mar 08 2024

Author @ AdvisorWorld.com Inc

Introduction

When contemplating annuity investments, one is often confronted with the choice between fixed and variable options. Each offers distinct returns, features, and risks that can influence your retirement income. This article embarks on a comparative journey, delving into the nuances of fixed and variable annuities to help you grasp their fundamental differences and implications. 

I. Fixed Annuities

A . Interest Rates and Returns

  1. Predetermined, stable interest rates
  2. – Agreed upon at the inception of the contract
  3. – Insulates your investment from market volatility
  4. – Offers financial predictability over the contract period
  5. Predictable, consistent income stream
  6. – Regular, fixed payments throughout the annuity term
  7. – Ideal for investors seeking financial security and a stable retirement income

B. Risk Profile

  1. Sheltered from market fluctuations
  2. – Investment performance independent of stock market behavior
  3. – Less susceptible to economic downturns
  4. Lower risk exposure
  5. – Attractive to conservative investors who prioritize capital preservation
  6. Example: Suppose you invest $100,000 in a fixed annuity with a 3% guaranteed interest rate. Regardless of market performance, your annuity will generate $3,000 annually, providing a stable income stream and peace of mind.

Variable Annuities

A . Interest Rates and Returns

  1. Performance-based returns
  2. Tied to underlying investment options, such as stocks, bonds, and money market accounts
  3. Returns fluctuate based on the performance of chosen investments
  4. Potential for higher returns or losses
  5. Opportunity for gains during bullish market conditions
  6. Possibility of losses during bearish market condition

B  Risk Profile

  1. Exposed to market volatility
  2. Returns directly linked to the performance of chosen investments
  3. Potential for short-term fluctuations in account value
  4. Higher risk exposure
  5. Suitable for investors with higher risk tolerance and longer investment horizons

C. Example: Investing $100,000 in a variable annuity with a mix of stocks, bonds, and money market accounts could yield significant returns if the market performs well. Conversely, poor market performance may lead to diminished returns or even losses, requiring a higher risk tolerance.

Comparison: Fixed vs. Variable Annuities

  1. Fixed Annuities offer:
  2. Stability and predictability
  3. Regular, consistent income payments to support retirement expenses
  4. Lower risk exposure
  5. Reduced sensitivity to market conditions, minimizing potential losses
  6. Variable Annuities provide:
  7. Potential for higher returns
  8. Opportunity to capitalize on market upswings and outpace inflation
  9. Exposure to market volatility

Greater reward potential with increased risk, requiring careful consideration of risk tolerance

Additional Considerations

Fees and Charges

Both fixed and variable annuities come with various fees and charges that can impact your overall returns and investment performance. Fixed annuities generally have lower fees, while variable annuities may include management fees, mortality and expense risk charges, and other costs associated with the underlying investment options. In addition, both types of annuities may impose surrender charges if you withdraw funds before the end of the contract term. It’s important to carefully review the fees and charges associated with any annuity before making an investment decision.

Tax Implications

Annuities provide tax-deferred expansion, signifying that taxation on your gains is postponed until you extract the capital. Nevertheless, the tax ramifications of fixed and variable annuities may fluctuate, hinging on aspects like the classification of the annuity as either qualified or non-qualified, in addition to the chronology of disbursements. To thoroughly comprehend the tax consequences tied to your annuity, seek counsel from a financial consultant or taxation specialist.

Annuity Riders

Annuity riders are optional features that can be added to your contract to customize your investment and address specific needs or concerns. Common riders available for both fixed and variable annuities include guaranteed lifetime withdrawal benefits (GLWB), long-term care (LTC) riders, cost-of-living adjustment (COLA) riders, and death benefit riders. The availability and cost of these riders will vary depending on the specific annuity product and provider

n summary, when scrutinizing fixed and variable annuities, thoughtfully weigh your monetary aspirations, risk receptiveness, and investment timeframe. Fixed annuities cater to individuals desiring a steady income stream, whereas variable annuities could entice those amenable to embracing market risk for the prospect of elevated gains. A meticulous examination of these disparities, coupled with advisement from a financial expert, can steer you toward the most fitting investment verdict for your retirement requisites.