GR Focus Finance

Not many beginning investors understand how a variable annuity works. But the investment products are actually rather simple. And they may have a place in your investment portfolio.

At their most basic, variable annuities, like fixed income annuities, are a contract between an investor and an insurance company. Investors agree to pay, either in a series of payments or in one lump sum, a fee to the insurance company. The insurance company then agrees to send payments to the investors either immediately or at a future date.

The annuity’s managers will invest the payments they receive into a range of investment options, usually mutual funds. Of course, because the performance of these funds is not guaranteed, investors will either see their investments increase in value or fall. This is no different than investing in mutual funds or stocks in general.

Annuities do differ in that insurance companies will send investors in a variable annuity a stream of payments on a regular basis. These payments, which usually come every month in the form of a check, can last for a set period of time, such as 20 or 30 years, or for an indefinite period, such as the lifetime of the investor.

Because of this “checks for a lifetime” option, many older investors place some of their dollars in variable annuities. They like the idea of receiving that extra check. It provides them with a boost in their financial security.

Variable annuities also have another benefit: Their earnings are tax-deferred. This, too, appeals to a lot of investors who are seeking tax havens for their dollars.

Finally, many variable annuities provide a death benefit. When investors pass away, the annuity pays a lump sump to the investors’ named beneficiaries. This lump sum is usually the annuity’s account value or an agreed-upon minimum payment, whichever is greater at the time of the investor’s death.

Those are some heady benefits. But variable annuities, and all annuity products, do have their critics. The critics point out that some life insurance companies charge investors hefty fees for the right to put their dollars in an annuity. Others don’t like the sometimes hard sell that life insurance companies engage in when trying to sing investors up for their annuity products.

Like all investment opportunities, variable annuities come with their own set of positives and negatives. It’s up to individual investors to do the research needed to determine if any kind of annuity is right for them.