DEFINITION of 'Variable Annuitization'

An annuity option in which the amount of income payments received by the policyholder will vary according to the investment performance of the annuity. Variable annuitization is one option that can be selected by the policyholder during the annuitization phase of a contract, which is the phase in which the policyholder begins making systematic withdrawals over a fixed period of time.  

BREAKING DOWN 'Variable Annuitization'

There are two phases to the life of an annuity. During the deferral phase an investor adds into the annuity, with all earnings that accrue during this phase being exempt from income tax. Once a policy holder is ready to start withdrawing funds from the annuity the phase changes from deferral to annuitization, and the investor can choose to either take fixed or variable payments. During the annuitization phase, the funds withdrawn are treated as income rather than capital gains. The complexity of annuity income tax treatment is greater with variable annuities than with fixed annuities.

Variable Annuity Considerations

Choosing how to receive payments from an annuity can be difficult for investors, and often comes down to the amount of risk the policyholder is willing to take compared with the amount of returns the policyholder wants. Choosing a fixed annuitization means that the policyholder will receive the same amount of money over the life of the annuity, regardless of how the portfolio of the annuity company performs. Variable annuitization payments differ in that the value received by the policyholder can vary from time to time. This is because the payments are based off of the performance of an underlying portfolio.

Purchasing an annuity can provide a level of income security, but can also lock in funds into a specific product that may not perform as well as expected. Professionals who sell annuities typically receive a commission based on the type and value of annuity sold. Variable annuities can be tied to the performance of benchmark indexes and baskets of securities. 

"The variety of features offered by variable annuity products can be confusing," FINRA, which regulates advisors, stated on its website. "For this reason, it can be difficult for investors to understand what's being recommended for them to buy—especially when facing a hard-charging salesperson. Before you consider purchasing a variable annuity, make sure you fully understand all of its terms. Carefully read the prospectus."

The organization recommends asking these questions: "How long will my money be tied up? Are there surrender charges or other penalties if I withdraw funds from the investment earlier than I anticipated? Will you be paid a commission or receive any type of compensation for selling the variable annuity? How much? What are the risks that my investment could decrease in value? What are all the fees and expenses?"

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