Basic Facts about Variable Annuities

Transcription

1 Basic Facts about Variable Annuities Variable annuities are long-term investment vehicles that provide a unique combination of insurance and investment features. Fundamentally, a variable annuity is an insurance contract you buy from an insurance company. At the same time, a variable annuity is an investment that is registered with the U.S. Securities and Exchange Commission (SEC). In fact, variable annuities are called variable because their value will fluctuate based on performance of the underlying stock, bond and money market investments you choose within them. Designed for Retirement Variable annuities are designed to address concerns many people have about outliving their assets or maintaining their standard of living in retirement. As the retirement landscape changes, with people living longer yet fewer receiving pensions, these concerns are growing. The payout phase of an annuity can provide regular income for years, or even for life. With the optional income guarantees that are becoming popular, variable annuities can also address concerns about investing in the stock market as one nears retirement, when there is less time to recover from a market downturn. For the right situations, variable annuities can offer benefits, but in order to maximize these benefits, you should understand how variable annuities work and be aware of their restrictions and fees. Before you purchase a variable annuity, you should receive a prospectus that explains the product and any fees in detail. Be sure to read it and ask your insurance-licensed representative questions about anything you don t understand. This brochure explains additional information to help you understand variable annuities before you purchase one. Other Types of Annuities You may also hear about fixed annuities. While a variable annuity fluctuates in value based on the performance of its underlying annuity portfolios, a fixed annuity provides a specified fixed rate of return. An equity-indexed annuity is one form of a fixed annuity where the interest rate is tied to the performance of a common equity market index, such as the S&P 500, Russell 1000 or S&P 100. Both variable and fixed annuities are also classified by when payouts occur. If payments are delayed to the future, the annuity is a deferred annuity. If payments start immediately, it is an immediate annuity. An annuity may also be a single-premium annuity, which is purchased with one payment, or a flexible premium annuity, purchased with multiple payments, which may be regular or occasional.

2 Variable Annuities: From Investment to Income Variable annuities have two phases. Accumulation phase, during which you can build assets for retirement through your selection of annuity por tfolios. Payout phase, during which you receive payments in either a lump sum, periodic withdrawals or through the process of annuitization, which converts your assets into an ongoing income stream. Under most contracts, this income stream can be set up for a defined period of time or to last your lifetime. Purchasing an Annuity All states have laws that give you a set number of days to look at an annuity after you buy it. Called the free look, this period allows you to change your mind. If you decide during the free look period that you don t want the annuity, you can return it and get your money back. Your contract and the annuity prospectus will describe this free look period. Variable Annuity Features Investment options: When you purchase a variable annuity, you choose from among a selection of underlying annuity portfolios and possibly fixed income choices available in the contract. These annuity portfolios are not available directly to the public; rather they are available only within variable annuity contracts or other products typically issued by an insurance company. As with publicly available mutual funds, annuity portfolios have their own distinctive investment objectives and policies, and typically offer exposure to stock or bond market returns. Another thing to note is that a variable annuity contract holder does not invest directly into these annuity portfolios (as you would do with a publicly available mutual fund). Annuity contract holders invest in subaccounts available in the variable annuity, which in turn pool the assets and invest in the underlying portfolios. The annuity portfolios generally cover many asset classes and investment strategies: equity, fixed income, balanced and money market funds, as well as value, growth, core and other strategies. Many variable annuities offer asset allocation programs that allow for a mix of asset classes according to your investment objectives, risk tolerance and financial situation. In most contracts, you may transfer in and out of variable investment options. As with any investment, there is potential for loss of principal. Death benefits: With an annuity, you name one or more beneficiaries. A death benefit is the sum your beneficiaries will receive when you die. Depending on the contract, the benefit can provide your beneficiaries a guaranteed minimum upon your death. The most basic death benefit is the return of account value, where your beneficiaries receive the current contract value. Return of premium, or an amount equal to everything you ve paid for the annuity, minus withdrawals, is another common death benefit. Another type pays the highest account value on any anniversary of the date the annuity was purchased. In any event, the death benefit proceeds bypass probate. If you have taken withdrawals from the annuity, the death benefit will be reduced accordingly. If your spouse is the beneficiary of the annuity, some contracts allow your spouse to become the new owner of the contract while still receiving a death benefit. Riders: Some annuities offer optional features called riders that provide additional benefits for additional cost. For example, some riders protect against market, inflation or longevity risk. A rider may also be an enhanced death benefit or a benefit to allow for continued income for your spouse if you die.

3 Living benefits: Although annuities are investments and there is a risk of losing money, some annuities, for additional cost, offer optional riders called guaranteed living benefits that protect against loss or help address concerns about outliving savings. Not all contracts offer living benefits, but they are becoming more common. One type of living benefit that is becoming widespread is a guaranteed lifetime withdrawal benefit (GLWB). A GLWB offers a guaranteed income stream for life while allowing full access to your account value. These guarantees can provide you with the peace of mind that no matter how long you live and no matter what direction the market takes, you will receive guaranteed income for life. It is important, however, that you understand any restrictions or fees before you purchase the GLWB and that you feel comfortable with its terms and conditions. Tax treatment: Annuity earnings are tax deferred during the accumulation phase, which means you do not pay taxes on any earnings each year; you pay taxes on earnings only when you withdraw your money. Any payouts are taxed as regular ordinary income and you may be subject to a 10 percent penalty if you take them before age 59 1 / 2. Another feature of most variable annuities is that they do not require a minimum withdrawal at age 70 1 / 2 as do IRAs, 401(k)s and other qualified plans. Costs and Considerations Variable annuities are not all the same. Be sure you understand the costs and other considerations associated with any variable annuity. Fees The fees on your variable annuity are typically assessed as a percentage of your variable annuity account value. These fees can vary widely. Also, note that not all variable annuities charge all these fees. The following are some typical fees you may see in a variable annuity. Mortality and expense risk charge (M&E): This charge covers the insurer s expense for some of the key insurance guarantees of the contract such as the standard death benefit, or for annuitization the annuity payout option that can provide guaranteed income for life. Administrative charges: Some contracts assess these charges to compensate the insurance company for administrative costs associated with the contract, such as preparing the prospectus, annual report, and legal and accounting expenses. Underlying fund expenses: These cover the management of the underlying annuity portfolios in which you ve allocated your assets. Rider fees: These fees compensate the insurance company for any optional features and guarantees beyond the standard annuity contract. You only pay rider fees for the riders you ve selected. Riders might include stepped-up death benefits, GLWBs and other living benefits, or principal protection for your spouse if you die, to name a few. Other Considerations Surrender charges: Be sure you understand what s involved if you want to take money out of your annuity. Because variable annuities are designed to be long-term investments, if you withdraw money before a certain point in the contract, you may incur a surrender charge, also known as contingent deferred sales charge (CDSC), that could affect the value of your contract. You can find information about any surrender charges spelled out in the annuity prospectus. Not all variable annuities, including those at Schwab, impose surrender charges.

4 Load or no-load: With a no-load variable annuity, you do not pay an upfront commission when buying the annuity, nor would you pay any surrender charges if you withdraw your money early from the contract. Variable annuities at Schwab are no-load. Market risk: The underlying annuity portfolios (and their corresponding subaccounts) are subject to market risk and are not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other government agency, nor are they a deposit of or guaranteed by any bank affiliate. The amount you invest may be more or less than the amount that is available at the time of withdrawal. Qualified retirement plans: Annuities may be purchased through regular contributions to a 401(k), IRA or other retirement account. These accounts, however, already provide tax-deferral; a variable annuity does not provide any additional tax benefit. There may be additional benefits (such as a living benefit) that would warrant your consideration of a variable annuity in your retirement account, but you should carefully evaluate these benefits and their costs before you purchase. The insurance component: While variable annuities are investment products registered with the SEC, they are also insurance products. The insurance company issuing the annuity supports the guarantees, such as any death and living benefits. To support these guarantees, the insurer must set aside capital and reserves to cover these obligations. The guarantees are only as good as the insurance company backing them. It is important to know the insurance company s financial strength and its ratings as you evaluate a variable annuity. Bonus credits: Bonus credits can add a specified percentage to the initial amount invested in the variable annuity, but they often have higher charges or longer surrender periods, so in the long run any upfront gains may be negated. Schwab variable annuities do not offer bonus credits, but some variable annuities do. Exchanges Section 1035 of the Internal Revenue Code permits an exchange of one annuity for another without triggering the taxation of any investment gains at the time of the exchange. This is known as a 1035 exchange. The annuity contract must be exchanged for a new or an existing annuity contract. If you receive a check and apply the proceeds to purchase a new contract, it would not qualify as a 1035 exchange, so you would be subject to paying current taxes and possible tax penalties at that time. Some clients might want to exchange their current variable annuity for another annuity to save on annual annuity fees. Others might exchange their annuity for an annuity that offers additional benefits or guarantees which better suit their needs. Be sure to weigh the potential benefits of any exchange, such as lower fees or more investment choices, against the potential drawbacks, such as surrender or withdrawal charges or a lower death benefit. Also be mindful of any guarantees, such as a GLWB, which you ve accrued; these guarantees may be for feited with an exchange to a new contract. Questions Discuss your situation with a Schwab insurance-licensed annuity specialist for more information and to learn whether a variable annuity is right for you. Call , Monday through Friday, 6 a.m. to 4:30 p.m. PT, or visit

5 The Language of Variable Annuities Annuitization The conversion of an asset into an income stream for either a set period of time or for life yours, or yours and your spouse s, depending on the contract. Generally, once an annuitization begins, it is irrevocable. Death benefit Payments made to a named beneficiary according to terms of an annuity contract. Typically, variable annuities provide a death benefit equal to premiums paid less withdrawals, but there are variations. Any death benefit proceeds bypass probate. Deferred annuity An annuity that does not make payments when the annuity is purchased but defers payments into the future. Any earnings are tax deferred until withdrawn. Dollar-cost averaging Allowed by most variable annuities, dollar-cost averaging involves periodic investments into an annuity over time, at varying price levels, with the goal of reducing investment risk and increasing return potential. The cost basis is the average cost of the continuing investments. This practice is limited to flexible premium variable annuities and must be chosen; it is not automatic. Early withdrawal Withdrawals made before the end of a surrender period as defined in the annuity contract. Also, any withdrawals made before the annuitant turns 59 1 / 2, in which case an early withdrawal federal tax penalty of 10 percent may be imposed. Fixed annuity An annuity that earns a specified fixed rate of interest during the accumulation period and makes fixed payments. Immediate annuity An annuity with a payment period that begins when the annuity is purchased. There is no accumulation phase with this type of annuity. Liquidity The ability to turn an investment into cash. Living benefit Variable annuity benefits for you during your lifetime, such as guaranteed income payments. Mortality and expense risk charge (M&E) The fee charged by an insurance company to cover the expense for some of the key insurance guarantees of the contract, such as the death benefit and lifetime annuity payout options (annuitization). Rider An optional benefit that is offered for an additional charge. Riders allow you to add the options that are most important to you. Payout phase The period after the accumulation phase, when payments are made. Premium The amount paid for an annuity. A singlepremium annuity is purchased with one payment. A flexible-premium annuity can be purchased with a series of payments. Subaccount The investment options in a variable annuity in which contract owners allocate their annuity assets. These subaccounts pool investor assets and invest in corresponding underlying annuity portfolios. These professionally managed annuity portfolios aren t available to the public but are available only through variable annuities and, typically, other insurance products. Surrender charge A charge imposed for taking money out of your annuity before the completion of a certain period in the contract known as the surrender period. The typical surrender period is seven years but sometimes longer. Not all variable annuities, including those at Schwab, impose surrender charges. Variable annuity A contract purchased from an insurance company with the goal of accumulating assets for retirement. A variable annuity fluctuates in value based on the performance of the investment options chosen exchange Named for Section 1035 of the Internal Revenue Code, this is the exchange of an annuity contract you own into a new or existing annuity contract without triggering the need to pay taxes on any investment gains earned on the original contract. To qualify, the contract must be exchanged for a new or an existing contract; if you receive a check and apply the proceeds to purchase a new contract, it would not qualify as a 1035 exchange, so you would be subject to current taxes and possible tax penalties.

6 Charles Schwab Insurance Services Charles Schwab & Co., Inc., distributes variable annuity contracts that are issued by insurance companies not affiliated with Schwab. Not all products are available in all states. All guarantees and protections are backed by the claims-paying ability of the issuing insurance company. You can find more information about variable annuities, their risk factors, fees and surrender charges through a prospectus. Variable annuities are sold by prospectus. Both the product prospectus and underlying annuity portfolio prospectuses can be obtained from your investment professional or by writing to the insurance company directly. Before investing, carefully consider the variable annuity s investment objectives, risks, charges and expenses. The product prospectus and underlying fund prospectus contain this and other important information. Please read the prospectuses carefully before investing or sending money. For a product prospectus or more information, call Charles Schwab Insurance Services at Charles Schwab & Co., Inc. All rights reserved. Member FINRA/SIPC. REF1182 ( ) REG42093 (05/08)