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Indexed Annuities Vs. Variable Annuities

Omkar Phatak Aug 21, 2020
There are various investment vehicles that one can choose to achieve short term and long term financial goals. Piecing together an investment portfolio that can effectively deal with risk in the long term and generate sizable returns for a financially secure future can be a daunting task.
You must pass every investment option under the microscope and evaluate it in detail. If you are thinking about long term investments, annuities are financial products that deserve consideration.
Two of the most popular types of annuities are fixed and variable annuities. Both guarantee a fixed amount of return on your investment, with a variable part that is dependent on market performance. However, both differ in the manner in which the variable part is associated with performance of market listed securities.

About Annuities

Here are the features of annuities as financial products marketed by insurance companies, before we compare specific types. You buy an annuity contract with an insurance company by making a lump sum payment or you pay via installments.
After this payment period, your investment remains locked with the investment company, grows tax free, according to the interest rate promised by annuity contract. When lock in period is over, you start getting fixed payments till the end of your days or till a fixed period.
That's why, annuities are perceived as some of the best retirement investments. Most importantly, returns at a fixed interest rate are guaranteed by the insurance company. For your investment to grow, the insurance company must invest it somewhere. Depending on how that investment is made, the terms of your annuity contract vary.
The simplest kind is a fixed annuity, that provides you with returns at a fixed interest rates and then there are the more complex types like indexed and variable annuities, which provide a variable interest rate.

Indexed Annuities Vs. Variable Annuities Comparison

An annuity whose performance and returns are linked to performance of a market index like S&P 500, NASDAQ or DJIA (Dow Jones Industrial Average) is called indexed annuity. Based on how the bunch of blue chip stocks, deciding the index value perform, the returns are decided. Each insurance company has its way to calculate returns, based on index performance.
The rate of interest which determines the returns, increases or decreases according to the performance of the index, but a minimum interest rate of return is guaranteed. There is a maximum cap on the amount of interest rate that your investment can earn and there are management fees charged which limit your return amount.
So in short, equity indexed annuities guarantee a basic minimum amount of return plus a variable part which is dependent on how well a market index performs.
Let us now compare an indexed annuity with a variable annuity. Unlike the indexed annuity, variable annuities invest your money in stocks and bonds via mutual funds. Your annuity account is divided into sub-accounts with each invested in a separate investment vehicle. Most companies let you decide the securities in which you would like to invest your money.
Generally, one of the sub-accounts is devoted to money market investments like certificates of deposit. A fixed amount of return, at a fixed interest rate is guaranteed, but the variable part is dependent on the performance of your portfolio of investments. Thus variable annuities spread over the risk by investing money in diverse options.
It is a matter of debate as to which among them comes with a greater degree of risk as both are inextricably linked with market performance of securities. While one is linked with the performance of market index, the other one is linked with a diverse portfolio which includes mutual fund investments and money market accounts.
As discussed before, variable annuities give you a choice in deciding which mutual funds you would like to invest in, while indexed annuities don't provide you with any amount of control.
Whichever of the two annuity types you think of opting for, make sure that you check the prospectus carefully and check out the fees and commission clauses in particular, which eat into your returns. Consult a financial advisor who understands your priorities, regarding which kind of annuity would be best suited for your plans.