What Are Step Ups in Variable Annuities?

Variable Annuities

When you purchase a variable annuity, the insurance company adds your money to a professionally managed pool that purchases stocks, bonds and other investments. The value of the portfolio fluctuates with the markets. The reason people invest in a variable annuity, as opposed to, say, the guaranteed payments that come with an ordinary annuity, is that they anticipate higher returns (more money) in the long term.

Death Benefit

If you're thinking, "gee, that sounds an awful lot like a mutual fund," then you are correct. But there are important differences between mutual funds and variable annuities, one of which is the death benefit. The death benefit is a guaranteed payment to your beneficiaries. It is usually, but not always, the amount you invested (less any withdrawals you have made). Should your investment decline, your beneficiaries still receive at least the amount you invested even if the markets have declined. If the value of your investments has risen, then your beneficiaries inherit the higher value.

Step Up Feature

Variable annuities frequently offer a step up feature. A step up allows you to take advantage of rising markets by increasing the death benefit for your beneficiary. When the value of your investment rises, you can lock in the new higher amount, and that becomes the new guaranteed death benefit. In short, when markets are rising, you can step up your death benefit.

Fee, Not Free

Insurance companies charge fees for the guarantees and other features that come with variable annuities. Step ups have fees, and there will be certain restrictions on how often you can step up the death benefit. It is important to have this information explained to you by an insurance company representative before embarking on this investment path.

An example

Say you invest $100,000 in a variable annuity that has a death benefit equal to the amount you invested. After two years if the annuity has paid you $20,000, your death benefit would be $80,000. If the markets have lowered the value of your investments to $60,000, your beneficiaries would receive $80,000 should you die. If the markets have raised the value of your investments to $95,000, your beneficiaries would receive $95,000. The step up feature allows you to lock in the $95,000 as your death benefit. Even if the markets decline in the future, your beneficiaries are guaranteed the new, higher amount (less any withdrawals you make).