Legal Definitions - variable annuity contract

A variable annuity contract is a legally binding agreement between an individual and an insurance company. Under this contract, the individual makes payments (either a single lump sum or a series of payments) to the insurance company. In return, the insurance company agrees to make regular payments back to the individual, typically starting at a future date, often during retirement.

The distinguishing feature of a variable annuity is that the amount of these future payments is not fixed. Instead, it fluctuates based on the performance of underlying investment options chosen by the individual, such as mutual funds. This means the value of the annuity can increase or decrease depending on market conditions, offering potential for growth but also carrying investment risk.

Here are some examples to illustrate how a variable annuity contract works:

• Example 1: Retirement Savings with Growth Potential

  Sarah, a 45-year-old marketing executive, wants to supplement her 401(k) for retirement. She enters into a variable annuity contract with an insurance company, agreeing to make regular monthly contributions for the next 20 years. Within the annuity, she selects a portfolio of investment funds that align with her moderate risk tolerance. When she retires at 65, the payments she receives from the annuity will vary each month or year, directly reflecting how well her chosen investments performed over the two decades she contributed. If the investments grew significantly, her payments will be higher; if they performed poorly, her payments would be lower.

  This example illustrates how an individual uses a variable annuity contract as a long-term retirement savings vehicle, where the future income stream is directly tied to the performance of the underlying investments chosen within the contract.

• Example 2: Estate Planning for Future Generations

  David, a wealthy retiree, wants to ensure his grandchildren receive a potentially growing income stream after his passing, rather than a fixed sum. He purchases a variable annuity contract with a significant lump sum, naming his three grandchildren as beneficiaries. He chooses aggressive growth-oriented investment options within the annuity. The contract specifies that upon his death, the annuity will begin making periodic payments to his grandchildren. The amount of these payments will fluctuate based on the ongoing performance of the investments David selected, allowing for potential growth even after his lifetime.

  This example demonstrates the use of a variable annuity contract for estate planning, where the contract provides for beneficiaries with payments that can vary based on market performance, offering potential for increased value over time.

• Example 3: Investing a Windfall for Future Income

  Maria receives a large inheritance and decides to invest a portion of it to generate future income, accepting some investment risk for the potential of higher returns. She uses a lump sum to purchase a variable annuity contract. She selects a diversified portfolio of equity and bond funds offered within the annuity. Maria plans to start receiving payments from the annuity in 15 years. The amount of income she receives each period will depend on the cumulative growth or decline of her chosen investments over those 15 years, as well as during the payout phase.

  This example highlights how a variable annuity contract can be used to invest a lump sum, where the future income stream is directly linked to the performance of the chosen variable investment options, providing a flexible income solution.