For many investors, variable annuities have become the modern-day version of the personal pension plan. While our grandparents could often count on their employers' largess to provide a predictable cash flow for their golden years, our parents weren't always so lucky. Many of them worked a lifetime only to find out that the pension payments they had been counting on to put some gold in their golden years never panned out. Faced with the less-than-sunny outlook for the prospect of a steady stream of income provided by their employer, the sad state of affairs at the Social Security Administration, and the uncertainty of the stock market, many investors are turning to variable annuities as an alternative method of generating predictable, guaranteed retirement income. (The Demise Of The Defined-Benefit Plan and Is Your Defined-Benefit Pension Plan Safe? provides some additional insight into the bleak predictions for the future of employer-provided pensions.)

Build Your Own Pension Plan
Variable annuities can function much like 401(k) plans and other tax-deferred savings programs offered through employers. Investors put away a small amount of money on a regular basis over a long period of time. The money is invested in variable annuity subaccounts, which are essentially clones of mutual funds, where it grows tax-deferred until the investor retires. The subaccounts offer a wide variety of investment choices, including many options that mirror popular mutual funds offered through nationally recognized fund companies. (To learn about these accounts, read Subaccounts: As Good Their Clone Funds?)

If the subaccounts grow in value, the investor benefits. If the investor is concerned about the subaccounts losing value, for an additional fee, variable annuities can offer strong downside protection against stock market declines. The protection, known as a guarantee minimum withdrawal benefit (GMWB), guarantees that the investors will receive a specific payment amount regardless of the value of the underlying portfolio. Some guarantees provide that set payment for life, while others offer it for a set period of time or a set amount. A guaranteed return of 5% per year is not uncommon.

Alternative Perspective
Variable annuities have long been derided by critics who complain about the cost and complexity of these investments. The fees include money paid to the subaccounts for investment management, money paid to the insurance company for the guarantee, and money paid for administration and other expenses. The impact of these fees is a reduction in the return on investment when compared to the mutual funds after which the subaccounts have been cloned. The critics cite the cost and reduced investment returns as the price for purchasing insurance that you don't need. (The Cost Of Variable Annuity Guarantees explains how these products tempt investors with some impressive benefits, but that the benefits come at a price.)

Critics also cite the lack of liquidity that comes with these investments, as there are various stipulations regarding the length of time the money must be invested in order to benefit from the guarantees, restrictions on early withdrawals, etc. (Variable Annuity Benefits: What The Fine Print Won't Tell You provides additional insight into some of the critics concerns.)

New Reality
The bear market of 2008 invalidated most of the criticisms that variable annuities have faced. While many investors lost 40% or more of their retirement nest eggs, variable annuity investors that opted for the guarantees earned exactly what they expected to earn. Even when several major insurance providers, including Hartford Financial Group Inc. and Lincoln National, had to accept bailout money from the federal government, the variable annuity investors got paid.

Is a Variable Annuity the Right Choice for You?
Variable annuities with the downside protection guarantee represent a more conservative approach to retirement. Yes, they cost more than other options. Yes, the returns are lower. Yes, there are complex provisions that you need to understand before you buy and various limitations and restrictions that will apply after the purchase. There are also theoretical concerns about the long-term financial stability of the firms providing the benefits - although research into the topic is likely to reveal that the money is theoretically set aside at the time of investment and that the investors should expect to get paid no matter what happens to the insurance company.

Conclusion
If you understand the potential concerns and view them as inconsequential when compared to a guaranteed income, variable annuities may have a place in your portfolio. Of course, investing in a variable annuity doesn't mean that you should neglect other options. There's nothing wrong with maximizing the amount you invest in your employer-sponsored retirement savings plan or your IRA before committing cash to a variable annuity. Having a diversified portfolio can mean more than just having a mix of stock, bonds or cash in your account. It can also mean having a portfolio of your nest egg invested in a variety of different accounts, one of which just may be a variable annuity with a guaranteed payout. (For more, see Getting The Whole Story On Variable Annuities.)

Related Articles
  1. Retirement

    Ten Social Security Questions Everyone Asks

    The average American doesn’t know enough about Social Security. Here are answers to 10 of the more common questions people ask about our retirement system.
  2. Mutual Funds & ETFs

    Invesco’s Top Funds for Retirement

    Here's a list of Invesco investments—retirement funds—that may work for you if you have the time to let them mature over the long term.
  3. Mutual Funds & ETFs

    Top 4 Royce Funds for Retirement Diversification in 2016

    Discover four of The Royce Funds mutual funds suitable for diversifying retirement portfolios that focus on investing in small-cap companies.
  4. Savings

    What Your Credit Score Means for Your Love Life

    Wondering if your significant other wants to commit and is reliable? The Fed might have the answer.
  5. Mutual Funds & ETFs

    Top 3 VALIC Funds for Retirement Diversification in 2016

    Learn about the VALIC fund family, its performance relative to its peers and the top three VALIC funds to consider for retirement diversification in 2016.
  6. Your Clients

    Tips for Making Your Nest Egg Last Longer

    If you’re trying to figure out how to make your hard-earned nest egg last, there’s one piece of advice that stands above the rest.
  7. Mutual Funds & ETFs

    The 4 Best T. Rowe Price Funds for Growth Investors in 2016 (TROW)

    Discover the four best mutual funds administered and managed by T. Rowe Price that specialize in investing in stocks of growth companies.
  8. Mutual Funds & ETFs

    The 3 Best T. Rowe Price Funds for Value Investors in 2016

    Read analyses of the top three T. Rowe Price value funds open to new investors, and learn about their investment objectives and historical performances.
  9. Mutual Funds & ETFs

    Top 3 Lazard Funds for Retirement Diversification in 2016

    Learn about Lazard Asset Management, its long history of strong performance and the top three Lazard funds to consider for retirement diversification.
  10. Investing

    3 Healthy Financial Habits for 2016

    ”Winning” investors don't just set it and forget it. They consistently take steps to adapt their investment plan in the face of changing markets.
RELATED FAQS
  1. Can a variable annuity be rolled into an IRA?

    You can roll qualified variable annuities, such as other qualified retirement plan accounts, into a traditional IRA. Non-qualified ... Read Full Answer >>
  2. How liquid are BlackRock mutual funds? (BLK)

    BlackRock, Inc. (NYSE: BLK) mutual funds are very liquid, as are all mutual funds. An investor receives payment for a redemption ... Read Full Answer >>
  3. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  4. What is after-hours trading? Am I able to trade at this time?

    After-hours trading (AHT) refers to the buying and selling of securities on major exchanges outside of specified regular ... Read Full Answer >>
  5. Am I losing the right to collect spousal Social Security benefits before I collect ...

    The short answer is yes, if you haven't reached age 62 by December 31, 2015. The Bipartisan Budget Act of 2015 disrupted ... Read Full Answer >>
  6. Are target-date retirement funds good investments?

    The main benefit of target-date retirement funds is convenience. If you really don't want to bother with your retirement ... Read Full Answer >>
Hot Definitions
  1. Harry Potter Stock Index

    A collection of stocks from companies related to the "Harry Potter" series franchise. Created by StockPickr, this index seeks ...
  2. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  3. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  4. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  5. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
Trading Center