Variable Annuity Vs. Index Funds
- A variable annuity is an insurance contract between an insurance company and a person. You can make one payment to the insurance company or a series of payments to pay for the variable annuity. The insurance company, in turn, guarantees payments to the variable annuity buyer. These payments can begin immediately or at some point in the future. Insurance companies invest money received from variable annuities in mutual funds or some other type of investment vehicle. The rate of payment offered by the insurance company depends on the performance of this underlying investment.
- An index fund is a type of unit investment trust (UIT) or mutual fund. A UIT is not managed and invests in a fixed portfolio of securities. A mutual fund, on the other hand, is a type of investment in which the issuing company pools money from several investors to purchase stocks, bonds and money market funds. Mutual funds are actively managed. The objective of an index fund is to meet or exceed the same return as a specific market index -- a basket of investments that share something in common. For example, the investments could belong to the same industry. The Dow Jones Industrial Average is an example of a well-known market index.
- Several differences exist between variable annuities and index funds. Variable annuities offer periodic payments, tax deferment and a death benefit. The periodic payments offered by variable annuities vary according to the account`s value, and this value changes with the performance of the underlying investment. Variable annuities also offer a tax-deferred benefit. You do not have to pay taxes on funds invested in variable annuities until you withdraw them. However, if you withdraw before retirement age, you will pay a 10 percent penalty fee. The actual death benefit of a variable annuity varies depending on the annuity and the rules specified in the annuity's contract.
- Another difference between an index fund and a variable annuity is the fee: The average fee on a variable annuity is approximately 2 to 3 percent per year, and the average free on an index fund is approximately 0.5 percent per year. The additional cost associated with a variable annuity results from the extra benefits associated with this type of investment. You should carefully evaluate the specific costs before investing in either a variable annuity or an index fund and determine if the extra benefits offered by a variable annuity are worth the cost.