How do variable annuities work?
A variable annuity has two phases: an accumulation phase and a payout phase.
During the accumulation phase, you make purchase payments, which you can allocate to a number of investment options. For example, you could designate 30% of your investment to a bond fund, 50% to a U.S. stock fund, and 20% to an international stock fund. The money you have allocated to each mutual fund investment option will increase or decrease over time, depending on the fund’s performance so choose the investments wisely.
During the accumulation phase, you can transfer your money from one investment option to another without paying tax on your investment income and gains. However, if you withdraw money from your account during the early years of the accumulation phase, you may have to pay “surrender charges,” if the amount is over 10% (the free withdrawal amount each year). If you withdraw money from your annuity before the age 59½ you may have to pay a 10% federal tax penalty so plan wisely.
At the beginning of the payout phase, you may receive your purchase payments plus investment income and gains (if any) as a lump-sum payment, or you may choose to receive them as a stream of payments at regular intervals (generally monthly).
If you choose to receive a stream of payments, you may have a number of choices of how long the payments will last. Under most annuity contracts, you can choose to have your annuity payments last for a period that you set (such as 10 or 20 years) or for the lifetime of you and your spouse or other beneficiary).