Make the wrong move and you could forfeit a variable annuity's guarantees. istockphoto By Kimberly Lankford, Contributing Editor From Kiplinger's Retirement Report, June 2013 Variable annuities have become a huge business, holding more than $1.6 trillion in assets. Many of these annuities include guaranteed lifetime withdrawal benefits, which promise you'll receive a minimum amount of income each year for life, no matter what happens to your original investment.See Also: Understanding Annuities Special Report For most variable annuities with guarantees, you invest a lump sum in mutual-fund-like accounts within the annuity, and the value can grow with the investments. Most people buy these annuities in their fifties and sixties, and they let them grow tax-deferred for several years before starting to tap the account. Every year, you pay fees just to preserve the income guarantees—perhaps $17,000 over ten years for a $100,000 account. With the newest generation of products, you still have access to the underlying investment. But if you make a wrong move when you withdraw the money, you could forfeit the guarantees. Here's how to avoid variable annuity mistakes. Advertisement Switching to a new annuity. Guarantees on variable annuities sold in the late 1990s to mid 2000s tend to be much more valuable than guarantees on versions sold today. Some of the older annuities let you withdraw as much as 6% a year from the highest value the account reaches. After the market downturn in 2008, insurers began to reduce their risk on new annuities by boosting fees and lowering annual withdrawals to 5%. Many of the older annuities work like this: Say you invested $100,000 in a variable annuity with a 6% annual guaranteed withdrawal benefit. The market value of your investments rises to $130,000 but later drops to $80,000. Your guarantee will be calculated on a $130,000 "guaranteed value" rather than on the actual "account value." An annual withdrawal of $7,800 for life would be based on the guaranteed value. Some annuities promise that the guaranteed base will double if you wait ten years before withdrawing any money, no matter what happens to the actual investments. These old annuities can be a great deal, so be wary of any broker who wants you to switch out to buy a new product. Consider the source: Salespeople make new commissions when you buy a new annuity. A big downside to switching: In the example above, you would only get the $80,000 account value from the old annuity, not the $130,000 guaranteed value. "The guaranteed amounts never transfer over," says Michael Bartlow, an adviser for financial planning company VALIC, which sells annuities, in Hickory, N.C. "People need to take the time to figure out what they're walking away from." Also, it's unlikely that any annuity you may buy to replace it will offer a 6% guarantee, and you may have to pay a large surrender charge if you switch. Advertisement Not making the most of the guarantees. If you're paying from 0.95% to 1.75% a year in fees just for the guarantee, then you should invest that money more aggressively than your investments without guarantees. You take a risk with aggressive investments, such as growth stocks, but you could reap big gains. Remember, the lifetime guarantee is often based on the highest value the investments reach. So even if your investments take a hit for a few years, you'll have a guaranteed floor. And when the market rebounds, your guaranteed value will rise as well. Mark Cortazzo, a certified financial planner in Parsippany, N.J., who helps advisers and individuals analyze annuities, says that annuity owners shouldn't waste the guarantee. "If somebody has $100,000 to $200,000 in an annuity with an income guarantee, they're spending thousands of dollars a year in protection," he says. And annuity owners should coordinate their annuity investment strategy with their other investments, Cortazzo says. In 2000, after his first wife died, Bryan Davis invested in a Nationwide variable annuity that didn't have an income guarantee. After retiring as a middle-school physical education teacher, Davis moved from New York to Arizona. He bought a Sun Life annuity in 2010, which lets him withdraw 5% of the guaranteed value every year. Neither salesperson asked about his other investments, says Davis, 62. "They just wanted to make money off me," he says. Davis's current financial adviser asked Cortazzo to analyze the annuities. Cortazzo concluded that Davis's investments were totally wrong for the types of annuities he held. The annuity without the guarantee was invested primarily in stock funds, while most of the annuity with the guarantee was invested in a balanced fund. Advertisement Cortazzo recommended switching the Sun Life annuity into about 70% stocks. He then shifted some money in the Nationwide annuity from an aggressive small-company stock fund into a fixed account that pays a minimum of 3% interest. (Cortazzo's firm, MACRO Consulting Group, will review up to three annuities for $199. Go to www.annuityreview.com.) Withdrawing too much money. The annuities with guarantees generally let you withdraw up to 5% or 6% of your guaranteed value each year. But taking more money can reduce the guaranteed value, which will reduce your future guaranteed payouts—sometimes by a considerable amount. The result can vary by annuity. Cortazzo offers two hypothetical examples of how annuities change the guaranteed value if you withdraw too much. Both annuities have a $500,000 account value and a $1 million guaranteed value. You can withdraw 6% of the guaranteed value each year, for a withdrawal of $60,000. If you withdraw an extra $5,000 just once, one of the annuities will reduce your guaranteed value to $990,000, and your annual withdrawal will be $59,400. The other will slice the guaranteed value to $500,000—and your annual withdrawal will drop to $30,000. The lesson: Make sure you understand the impact of extra withdrawals on your guaranteed base. Advertisement Choosing the wrong beneficiary. Cortazzo noticed another problem with Davis's annuities. Davis had remarried, and he had been paying for a joint-life guarantee that would continue the Sun Life payouts for as long as he and his wife lived. But instead of making his wife the beneficiary, the brokerage firm where he bought the annuity had named his IRA as the primary beneficiary. His wife could receive the account value after he died, but the lifetime income would stop. "A spouse who isn't the primary beneficiary on an annuity can't continue the contract," says Cortazzo. Say your guaranteed value is $200,000 and you've been taking out 5% a year ($10,000), and the account now has just $40,000 in actual value. If your wife is the beneficiary on a joint-life annuity, she can receive $10,000 a year for life after you die. If she isn't the primary beneficiary, she'd only inherit the $40,000. Davis changed the beneficiary so his wife could receive the lifetime income. Haven't yet filed for Social Security? Create a personalized strategy to maximize your lifetime income from Social Security. Order Kiplinger's Social Security Solutions today.