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A variable annuity is an investment tool in which the individual pays a certain amount to an insurance company, who can then invest that money in certain investment options, such as bonds or stock, and at the end of a particular period of time, pay the individual back their money periodically.

There are two phases in a variable annuity, and the first one is the accumulation phase of the variable annuity, while the second one is its payout phase.

The accumulation phase involves payments by the individual to the insurance company. In this phase, the individual makes either a lump-sum payment or a series of individual purchases to the insurance company, and then chooses where the money should be invested. For example, the individual can decide that about 20% of their money should go to the purchasing of stock; 20% of their money should go to the purchase of bonds, while the remaining 60% could go to the purchase of other money market instruments.

Since all these investment options change with time, your investment will also go up and down with time and this will be judged by the performance of the option you choose. You, however, do not have to invest all your money as you can choose to leave some of it in a fixed account and this amount will not change at all. This means that the money in the fixed account will always pay the individual a fixed interest though the rate may be changed by the insurance company from time to time.

The prospectus provided to you by the insurance company is your most vital information source as it will give you details about all the investment options as well as any fees charged by the insurance company and all the expenses that you will incur as well as all the risks involved.

While your money is in the first phase, the accumulation phase of the variable annuity, you can move your funds around the different investment options without any tax being charged on the investment income or on any of the interest you gain. However, different insurance companies may charge you a certain amount of money as transfer charges. Money should not be withdrawn during this phase as you are likely to be charged ‘surrender charges’ by the insurance company. Most companies charge ‘surrender charges’ for withdrawal before 6 years, though some require as long as ten years before any money is withdrawn from your account. Money should also not be withdrawn before the individual reaches the age of 59 and a half as the federal government will charge a tax penalty of 10% for this withdrawal.

There are other types of variable annuities which do not have an accumulation period as they are immediate variable annuities. This means that the individual starts getting payment immediately after the purchase.

It is important for the investor to understand all the terms of the accumulation phase of the variable annuity, as well as any risks and the potential benefits of each investment option so that they can be able to make the best investment choice.