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5 Questions to Ask Before Choosing a Variable Annuity

Retirement Planning
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A retired couple smiles as they walk together in a park on a spring day: variable annuity

Retirement plans like 401(k)s and individual retirement accounts (IRAs) may offer tax benefits. However, the Internal Revenue Service (IRS) has strict limits on how much you can contribute per year through these accounts — and not everyone has access to a favorable workplace retirement plan.

So, what can you do if you want to put more aside for tomorrow? Variable annuities can also allow you to invest money in a tax-deffered manner. But could this annuity type be right for your needs? Here are some questions that may help you decide.

1. What Is a Variable Annuity?

A variable annuity is a type of contract you make with an insurance company. First, you add money to the annuity, either as a lump sum or through regular payments. From there, you invest your money into a variety of different subaccounts, designed by the provider of the annuity. These subaccounts contain things like stocks, bonds and cash equivalents. You can pick an allocation that matches your investment style.

When you enter retirement, you can set your annuity to make regular payments back to you. These can be monthly payments over a period, such as 10 years, or even regular payments guaranteed to last your entire life.

2. What Are the Benefits?

When you invest through a variable annuity, you delay taxes on your gains. As a result, you could earn a higher after-tax return on your subaccounts, although you'll still pay taxes at your ordinary income tax rate when you withdraw funds. It's important to note that in addition to any applicable fees and taxes owed on the withdrawal, withdrawals prior to age 59 1/2 may be subject to a 10 percent IRS penalty tax.

Also, since you're investing in market assets like stocks and bonds, you could potentially earn a higher return with variable annuities than with the guaranteed return on fixed annuities — but keep in mind this also means there's a potential you could lose more. Variable annuities can also offer certain guarantees, however, such as that you'll receive a minimum amount at retirement regardless of how your investments perform. (Keep in mind such guarantees are based on the ability of the insurer to pay the claims.)

3. When Can You Use a Variable Annuity?

Variable annuities are not workplace retirement plans, so you can set one up with a provider whenever you want. You don't need to rely on your employer to provide one! There are also no income restrictions, so you can purchase a variable annuity no matter how much you earn (though the insurer will typically set maximum contribution limits for the annuity and it could also be subject to IRS contribution limits).

4. What Are the Different Rates?

A variable annuity doesn't pay a set interest rate like a fixed annuity does. Instead, your account value changes based on the performance of the investment options (subaccounts) in your annuity, adjusted for charges, fees and expenses. You can divide your account value between a mix of different investment options or subaccounts as well.

5. Could It Be Right for You?

If you're maxing out your other retirement plans and want to save more in an account that may delay taxes, a variable annuity could be a solid choice. They could be a good fit when you're more risk-tolerant and are willing to accept some years with losses in exchange for a potentially higher long-term return.

Typically, the further you are from retiring, the more a variable annuity could make sense. These accounts invest in market assets where performance goes up and down. If you have many years before you need your money, you may have more time to wait out such swings.

Variable annuities are long-term investments designed for retirement. If you cancel your contract during the first few years (known as the "surrender period"), the provider of the annuity will deduct a surrender charge from your account before paying you the remaining balance.

Since variable annuities are designed for retirement purposes, the IRS wants you to keep your money in them until you turn age 59 1/2. If you want to make any withdrawal before then, you'll owe income tax and a 10 percent penalty on the amount taken out.

No one ever said they wished they paid more taxes on their retirement savings. A variable annuity offers another tax-deferred tool you can add to your retirement plan toolkit — and asking these five questions could help you decide if a variable annuity is right for your retirement needs.

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Securities offered by Registered Representatives through W&S Brokerage Services. Member FINRA/SIPC. All companies are members of Western & Southern Financial Group

Information provided is general and educational in nature. It is not intended to be, and should not be construed as, legal or tax advice. Western & Southern Financial Group and its member companies (“the Company”) does not provide legal or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. The Company makes no warranties with regard to the information or results obtained by its use. The Company disclaims any liability arising out of your use of, or reliance on, the information. Consult an attorney or tax advisor regarding your specific legal or tax situation.