Variable Contracts - Fixed vs. Variable Annuities
Before we delve into the specific differences between fixed and variable annuities, the article An Overview of Annuities looks at how annuities work and their benefits. We recommend a read if you need a quick primer.
Many retirees choose fixed annuities for their predictability, stability and guaranteed stream of income. With a fixed annuity, the life insurance company agrees to pay a fixed rate of income to the investor for life after a certain date.
Moreover, the insurance company assumes the risk of the performance of the annuity's securities by directing the investment of the annuitant's principal into a portfolio of fixed-income investments. When the annuitant decides to begin the payout phase, the amount of income he or she receives is determined by a combination of the account's value and the investor's mortality expectancy.
Take a deeper look into the types of fixed annuities within the article, Exploring Types of Fixed Annuities, which also details their advantages and disadvantages.
Variable annuities provide a slightly more complex trade-off to the investor: in return for assuming the performance risk of the underlying securities portfolio, the investor increases his or her potential for higher returns during an accumulation phase.
Unlike a fixed annuity, a variable annuity has no guaranteed returns because the investor's principal is invested in one or more sub-accounts made up of stocks, bonds and money market instruments. However, most variable annuities do offer a sub-account that has a fixed rate of interest. Nevertheless, the investor who wants to stay ahead of the rising cost of living will choose a variable annuity over a fixed one because the fixed annuity will lose its purchasing power over time. We will discuss sub-accounts and other features of variable annuities in the next section.
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You will need to know the differences between fixed annuities and variable annuities for the exam.