Not all annuities guarantee a fixed rate of return. With a variable annuity, your premiums are invested in a variety of subaccounts, similar to mutual funds. Each sub account has an investment objective and charges a management fee in addition to the insurance company’s fees.
The annuity’s rate of return is based on the performance of these subaccounts. The insurance company does not guarantee variable annuity rates, so the annuitant bears all of the investment risk.
In some ways, a variable annuity is like a 401(k) plan: You choose the subaccounts where your premiums are placed and thus the overall returns on your annuity. Generally, you have the opportunity for higher returns than in a fixed annuity. But markets are volatile, so there is downside risk as well.
Never buy an annuity for market growth, even though that’s how they’re sold. If you want market growth, you don’t need an annuity. You’d be better off just holding low cost mutual funds instead of incurring the high fees of variable annuities.
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