Variable annuities blend the dynamic returns of market-linked investments with the protection of insurance guarantees, offering a compelling option for long-term retirement planning.

Understanding Variable Annuities: Definition and Structure

A variable annuity is a contractual agreement between an individual and an insurance company. Investors make either a single or multiple premium payments, and in return, the insurer commits to provide future periodic payments in retirement.

The contract unfolds in two distinct phases: accumulation and payout.

Unleashing Growth Potential

Variable annuities often outpace fixed annuities in long-term performance because returns mirror the ups and downs of the underlying markets. By accepting market risk, investors gain access to market-linked growth opportunities over decades.

For investors with a horizon of 20 years or more, this strategy can lead to higher cumulative returns compared to bank accounts or conservative annuities, provided they ride out market downturns.

Retirement Benefits and Guarantees

One of the most compelling aspects of variable annuities is the suite of optional riders that enhance retirement security. A popular choice is the guaranteed lifetime withdrawal benefit rider, which ensures a minimum income stream for life regardless of market performance.

Another key feature is the death benefit: if the owner passes away before annuitization, beneficiaries typically receive at least the total premiums paid or the highest contract value on an anniversary, adjusted for withdrawals.

All earnings grow on a tax-deferred basis, offering a tax-deferral advantage through compounding growth until funds are withdrawn.

Market Trends and Statistics

Variable annuity sales rebounded sharply in 2024, reflecting renewed advisor interest and strong equity markets. Key metrics include:

• 2024 US sales of traditional variable annuities increased by 19% to $61.2 billion.
• Total US retail annuity sales reached a record $432.4 billion, buoyed by variable annuity innovation.
• LIMRA forecasts steady sales around $60 billion in 2025, assuming stable market conditions.

This resurgence follows a significant sales decline in 2023, underlining the sensitivity of variable annuities to market cycles and product enhancements.

Key Features and Customization

Variable annuities stand out for their flexibility:

• Unlimited contribution potential allows high-net-worth individuals to invest additional funds beyond IRA and 401(k) caps.
• A wide investment menu of subaccounts enables tailored asset allocation according to personal risk tolerance.
• Customizable riders let investors add guarantees for income, principal protection, or enhanced death benefits (with additional costs).

Risks, Costs, and Drawbacks to Consider

Despite their benefits, variable annuities carry complexities and expenses:

• Complex fee structures and annual charges shrink returns, including management fees, rider fees, and mortality expenses.
• Significant surrender penalties for early withdrawal can lock in capital for extended periods.
• Market exposure means account values can decline during downturns unless guaranteed riders are purchased at an extra cost.

Regulators have flagged aggressive sales tactics and high costs, and past industry events prompted insurers to raise rider fees and reduce benefit generosity.

Who Should Consider a Variable Annuity?

Variable annuities suit investors who:

• Have already maximized contributions to 401(k)s and IRAs and seek additional tax-deferred vehicles.
• Desire customizable retirement income guarantees and legacy benefits for beneficiaries.
• Possess a long time horizon and willingness to accept market volatility for higher returns.

They may not be ideal for those with short-term liquidity needs or very low risk tolerance.

Comparing with Other Annuity Products

Variable annuities compete with: fixed annuities, which provide safety of principal but limited growth, and fixed indexed annuities, which offer some upside linked to indexes while protecting against losses. Your choice depends on desired balance between risk and return.

Conclusion: Aligning with Your Retirement Strategy

Variable annuities offer a powerful blend of long-term growth potential and retirement income guarantees. However, the benefits come with trade-offs in fees and complexity.

Before committing, investors should assess their retirement goals, risk tolerance, and liquidity needs, and compare annuity features carefully. When chosen thoughtfully, variable annuities can play a pivotal role in a diversified retirement portfolio, delivering both growth and peace of mind.