Understand how variable annuities work and whether they might be right for you.
Here at TIAA, we’re big proponents of fixed annuities and the guaranteed lifetime income they provide in retirement. Fixed annuities give retirees greater freedom to spend, they reduce the risk of retirees outliving their savings, and they may even help retirees stay healthier for longer.1
We don’t talk nearly as much about variable annuities, even though TIAA pioneered the first variable annuity back in 1952. That’s probably because variable annuities can be complex, and complexity tends to be a tough sell for financial advisors and clients alike. Nevertheless, variable annuities can play an important role in retirement savings. With this in mind, In Balance recently sat down with TIAA retirement income strategist Rob Stevens to get answers to common questions about variable annuities and why savers might consider adding them to their retirement plans.
A variable annuity is a contract between you and an insurance company that allows for tax deferred accumulation and growth of your savings. While a fixed annuity guarantees a certain level of returns, as the name suggests, variable annuity returns vary and aren’t guaranteed. Money allocated to a variable annuity is invested in subaccounts of various asset classes: stocks, bonds, money market, etc. Variable annuity performance is tied to the underlying returns of the selected subaccounts.
During the accumulation phase—preretirement, in other words—variable annuities are similar to mutual funds (albeit with an insurance wrapper that affects the cost but can add some protection). The big difference comes in the decumulation phase—i.e., in retirement—when variable annuities give participants the option of converting their savings into a stream of lifetime income. That conversion is known as annuitization. Participants are under no obligation to annuitize, and those who don’t usually make withdrawals just as they would with a mutual fund. However, retirees who rely on a withdrawal strategy run the risk of outliving their savings, whereas those who opt for lifetime income know they’ll get a check every month—even if they live to 100 or beyond.
With a variable annuity, the size of each monthly payment reflects a combination of the gradual return of your original principal (based on age and actuarial tables) and the investment performance of the underlying subaccounts. Variable annuities generally have an assumed investment return (AIR), typically between 3% and 7%, that determines a standard monthly payment. If the investment performance is greater than the AIR, you’ll get more than the standard payment. If the investment performance is less, you’ll get less. (As we said, variable annuities can be complex, so talk to your TIAA financial advisor for details.)
If you choose single-life annuitization, payments end when you die. But most annuities give you a joint-life option of accepting a lower monthly payment in exchange for your partner continuing to receive payments as long they remain alive.
For better or for worse, shopping for a variable annuity is a bit like shopping for new car. You start out looking at the base model with the standard trim. But add in all the special features and options—some you need, some you probably don’t—and what started out as a $40,000 sedan is now closer to $50,000.
It’s a similar story with variable annuities. Some come with a monthly income floor that increases the fees. Others pay your heirs a death benefit for another fee. Some even have options that increase monthly payouts if you become disabled or require long-term care. Eventually, all those extras (also known as riders) add up—so it’s important to shop for variable annuities with a financial company and financial advisor you trust.
For those who want lifetime income, perhaps the biggest advantage is inflation protection. With a fixed annuity, the monthly payout you receive at age 67 is generally the same as the one you’ll get at 87—which would be fine if the cost of food, housing and medical care weren’t rising. Payments from a variable annuity are more likely to keep pace with inflation because the returns can be linked to the stock market.
Another advantage involves reassurance and ease. Once annuitized, a variable annuity becomes a set-it-and-forget-it source of retirement income. You don’t need to decide how much to withdraw each month because the decision has already been made—your payment is based on the performance of the underlying subaccounts. This is helpful because people are more prone to money mistakes as they age. If you fall victim to a fraud, for example, the most you can lose with an annuity is your monthly check, not your life savings. “Our mental faculties decline with age,” says Stevens, “and one key advantage of variable annuities is less decision-making.”
Talk to your TIAA Wealth Management advisor for more information on variable annuities and how they may fit into your financial plan. Don’t yet have an advisor? Schedule an appointment.
This material is for informational or educational purposes only and is not fiduciary investment advice, or a securities, investment strategy, or insurance product recommendation. This material does not consider an individual’s own objectives or circumstances which should be the basis of any investment decision. Converting some or all of your savings to income benefits (referred to as "annuitization") is a permanent decision. Once income benefit payments have begun, you are unable to change to another option. Annuity account options are available through contracts. These contracts are designed for retirement or other long-term goals, and offer a variety of income options, including lifetime income. Payments from the variable annuity accounts are not guaranteed and will rise or fall based on investment performance. Any guarantees are backed by the claims-paying ability of the issuing company.
Investment, insurance and annuity products are not FDIC insured, are not bank guaranteed, are not deposits, are not insured by any federal government agency, are not a condition to any banking service or activity and may lose value.
Advisory services are provided by Advice & Planning Services, a division of TIAA-CREF Individual & Institutional Services, LLC, a registered investment adviser. TIAA-CREF Individual & Institutional Services, LLC, Member FINRA, distributes securities products.
1 For example, according to a 2018 article in the Journal of Financial Services Professionals (Tricker, Patrick, “Annuities and moral hazard: Can longevity insurance increase longevity?” Journal of Financial Service Professionals, July 2018.), a 65-year-old male in the U.S. who purchases a life annuity can expect to live about 20% longer than a 65-year-old male who doesn’t. The traditional explanation for why people with annuities live longer has less to do with the annuities themselves than with those who purchase them. Quite possibly, individuals who buy lifetime annuities do so because they expect to live longer. Perhaps longevity runs in their families. Maybe they intend to eat well, exercise regularly and stay healthy. But there may be an additional explanation for the extended longevity among those receiving lifetime income: reduced stress. We know a majority of Americans are stressed about retirement savings (see: “Americans' Outlook for Their Retirement Has Worsened,” Gallup News, May 25,2023), and research also shows a strong correlation between high stress and reduced life expectancy, particularly among the elderly (see: Tian F, Shen Q, Hu Y, Ye W, Valdimarsdóttir UA, Song H, Fang F, “Association of stress-related disorders with subsequent risk of all-cause and cause-specific mortality: A population-based and sibling-controlled cohort).