The Variable Annuity

Shawn Plummer

CEO, The Annuity Expert

If you are looking for a way to save for retirement, you may have come across the term “variable annuity.” But what is a variable annuity, and is it right for you? This guide will discuss everything you need to know about variable annuities. We will cover topics such as how they work, the benefits of owning one, and choosing the right one for your needs. By the end of this overview, you will be able to decide if a variable annuity is right for you!

What is a Variable Annuity?

A variable annuity is a type of financial product that allows you to save and invest money for your retirement on a tax-deferred basis. It is called a “variable” annuity because the payments you receive from the annuity can vary based on the performance of the underlying investments.

With a variable annuity, you make one or more payments into the annuity, and the money is then invested in various assets, such as stocks, bonds, and mutual funds. The returns on these investments are used to fund the payments that will be made from the annuity at a later date, typically during retirement.

What Is A Variable Annuity, And How Do They Work?

How Do Variable Annuities Work?

Variable annuities are a popular long-term investment plan for retirement. These deferred annuities earn returns based on the performance of the underlying investments (stocks, bonds, mutual funds), also known as a subaccount.

Annuities are not insured by the FDIC or any federal government agency but are backed by the claims-paying ability of the issuing life insurance company. Luckily, every annuity company has a State Guaranty Association to back the provider in case of insolvency.

Accumulation Phase

During the accumulation phase, variable annuities earn investment returns based on the investment performance in various markets, known as “subaccounts.” The contract will offer investment choices likely to include subaccounts with different types and levels of risk.

The return earned in a variable annuity isn’t guaranteed. The value of the subaccounts you choose could go up or down.

If the subaccount values go up, an annuity owner could make money. If the value of these subaccounts goes down, you could lose money. Your annuity value will change daily based on the subaccounts’ performance.

However, you may allocate some of your investment choices into a fixed interest rate option guaranteed not to change for a specific period, typically one year.

Remember, a variable annuity is an investment, not an insurance-based product.

Tax-Deferred Growth

Variable annuity taxation is tax-deferred, which means you won’t pay ordinary income tax on earnings until you start withdrawing from the contract for income.

Distribution Phase

There is an optional payout period in every variable contract that is annuitizing your current annuity contract value. Most variable annuity owners don’t annuitize the contract. Instead, they purchase a living benefit (read below) to generate a lifetime retirement income.

Variable Annuity Subaccounts

The following are examples of the more common types of variable annuity subaccounts:

  • Money Market Subaccount: Assigned premiums are invested in short-term money market instruments to produce the highest current income while maintaining acceptable safety of principal and liquidity.
  • Stock Subaccount: To achieve capital growth, premiums are invested in common and preferred stock.
  • Bond Subaccount: Allocation premiums are invested in high-quality bonds intended to produce a substantial amount of income over the long term while delivering acceptable safety of principal.

When the contract owner decides where to invest the annuity premium, the annuity’s cash value fluctuates from day to day based on performance.

Pros and Cons

  • Tax-Deferred Growth for Retirement
  • Guaranteed Income for Life
  • Unlimited Growth Potential
  • Exposure to Market Loss (You can lose your retirement savings.)
  • Expensive Fees and Charges
  • Long Term Contracts
  • Tax consequences on withdrawals before age 59.5.

Living Benefits

Variable annuities offer optional features at an extra cost called riders. For example, a common rider, the Guaranteed Lifetime Withdrawal Benefit, guarantees a particular minimum level of annuity payments, even if you do not have enough money in your account (perhaps because of investment losses) to support that level of lifetime income payments. Other riders may include long-term care insurance, which pays for home health care or nursing home care if you become seriously ill.

Tip: If guaranteed lifetime income payments are what you seek, save money by purchasing a fixed-indexed annuity. The fixed index annuity’s income rider cost is a fraction of the cost and could provide guaranteed income payments larger than a variable annuity payment.

Guaranteed Minimum Accumulation Benefit

The Guaranteed Minimum Accumulation Benefit (GMAB) guarantees your account value will equal some fixed percentage (typically 100%) of premiums, less any annuity withdrawals, in the future if you stay in the contract and the account does not decrease to a value of zero.

The insurance company will add the difference if your variable annuity is worth less than the minimum guaranteed amount at that date.

Guaranteed Minimum Income Benefit

The Guaranteed Minimum Income Benefit (GMIB) guarantees a minimum lifetime income in retirement. The GMIB benefit is similar to a Deferred Income Annuity in that you invest money now and annuitize in the future. Typically the annuity owner must elect the guaranteed income benefit when you buy the annuity and must annuitize your contract at a future date to use the benefit, similar to the two-tiered annuity.

Guaranteed Lifetime Withdrawal Benefit

The Guaranteed Lifetime Withdrawal Benefit (GLWB) guarantees you can make withdrawals for the rest of your life, up to a maximum percentage each year.

Fees and Charges

Every annuity insurance company charges annuity fees for various riders, investment management, and other bells and whistles. One should expect to pay roughly 3% to 4% of your current contract value each year.

For example, if your variable annuity is worth $100,000, you expect to pay between $3,000 and $4,000 in fees this year.

Fees reduce the value of your annuity. However, they help cover the annuity company’s costs to sell and manage the annuity and pay benefits. The insurer may subtract these costs directly from your annuity’s value.

  • Surrender Charges: Variable products have surrender charges that you must pay if you take some or all of your money out too early. Some annuities have penalty-free withdrawals, which allow an allotted amount every year. Anything withdrawals over that allotted amount will succumb to a charge for every dollar above that amount.
  • Mortality and Expense Risk Charge: The mortality and expense risk charge compensates the insurance company for the risks it assumes under the annuity contract.
  • Administrative Fees: The insurer may deduct fees to cover record-keeping and other administrative expenses.
  • Underlying Fund Expenses: You will also indirectly pay the fees and expenses imposed by the mutual funds underlying investment options for your variable annuity contracts.
  • Rider and Benefit Fees: Any additional special features or benefits (riders) offered by some variable plans often carry additional fees.
  • Other Fees and Charges: You can also be charged fees such as initial sales loads or fees for transferring part of your account from one investment option to another, which may also apply.
  • Market Value Adjustment: Some variable contracts have a Market Value Adjustment (MVA), which could increase or decrease your annuity’s account value, cash surrender value, and/or death benefit value if you withdraw money from your account. In general, if interest rates are lower when you withdraw money than when you bought the annuity, the MVA could increase the amount you could take from your annuity. If interest rates are higher than when you bought the annuity, the MVA could reduce the amount you could take from your annuity.

Variable Annuity Death Benefits

Variable contracts offer a basic death benefit. If you die during the accumulation period, the standard death benefit pays some or all of the annuity’s value to your beneficiaries in a lump sum or multiple payments over time (annuitized payout).

The variable annuity death benefit amount is usually the greater of the annuity account value or the minimum guaranteed surrender value.

If you die after you begin to receive periodic payments (annuitize), your chosen survivors may or may not receive anything depending on the deceased’s chosen annuitized income payout option.

Variable annuity products can also offer an enhanced death benefit at an additional cost. The benefit will cover guaranteed death benefits if the annuity runs out of money.


How are Variable Annuities Taxed? These investment retirement plans are tax-deferred vehicles, meaning under current tax laws, any guaranteed interest rate or gain in an annuity is not taxable until you receive this income.

The power of tax deferral in variable annuities is the effect of “triple-compounding” on your retirement plan’s growth. Since you pay no taxes while your money is compounding, you earn interest in three ways:

  • Interest on your principal.
  • Interest on interest.
  • Interest on the taxes you would have paid if not tax-deferred.

Qualified Variable Annuities

Qualified Variable Annuities have a tax status of IRAs, 401k, SEP, and other employer-sponsored savings plans. Qualified plans are pre-taxed funds, so 100% of the income you withdraw will be subject to ordinary income taxes when you decide to withdraw any funds from the account.

The exception with qualified annuity contracts is the Roth IRA annuity. Therefore, all funds withdrawn from these contracts will be tax-free.

Non-Qualified Variable Annuities

Non-qualified plans are paid with “after-taxed” money, and owners are subject to paying income taxes on any interest credits (investment gains) earned that have not been taxed yet.

Variable Annuity Questions

Before you purchase a variable annuity contract, ask yourself these questions:

  • Will you use the variable annuity primarily to save for retirement or a similar long-term goal?
  • Are you willing to take the risk that your retirement plan may decrease if the underlying mutual fund investment options perform badly?
  • Do you understand all the features of your contract?
  • Do you understand the fees and expenses you will be charged?
  • Do you intend to remain in the contract long enough to avoid paying any surrender charges if you have to surrender the policy or withdraw money?
  • If you are offered a premium bonus, will the bonus outweigh any higher fees and charges that the product may charge?
  • Is there a cheaper option to achieve your retirement planning goals, such as retirement income, long-term care insurance, or life insurance?
  • If you are replacing one annuity for a new annuity, do the benefits of the new annuity contract outweigh the costs, such as any surrender charges you will have to pay if you withdraw your money before the end of the surrender charge period for the new annuity?

Which Two Entities Regulate Variable Annuities?

Variable annuities are regulated by the federal Securities and Exchange Commission (SEC), the financial industry regulatory authority (FINRA), and state insurance departments. They are considered securities and must comply with federal securities laws and regulations, with limited exemptions. Regulation by state insurance departments includes reviewing and approving variable annuity contracts offered to the public, examining and licensing companies’ market- Unit 12 Annuities 215 ing variable annuities, and licensing of agents who will sell variable annuities.

Due to this dual regulation, a financial professional who wants to sell variable annuities must pass a test and be registered with the Financial Industry Regulatory Authority (FINRA). The advisor must also be licensed to sell life insurance by the state. Some states have additional requirements and require an agent to qualify for a separate variable contract license.

Understanding Your Variable Annuity

When you receive your variable annuity contract, carefully read through it and review it.

Be sure every feature is what you understood your retirement plan would be.

There are disclosures, statements of understanding, or a prospectus to understand better what you have invested in.

Suppose you are worried or feel you haven’t purchased what you understood. In that case, there is always a free look period that gives you a set number of days (usually 10 to 30 days) to change your mind about buying an annuity after receiving it.

You can return the contract if you decide that you don’t want the annuity during the freelook period.

Variable Annuities vs. Fixed Annuities

Variable annuities were introduced in the 1950s as an alternative to fixed annuities due to low-interest rates.

Variable annuities are investments that give buyers the chance to benefit from rising markets. This is because they can invest in a menu of mutual funds that the insurer offers. The upside to this is that the buyer might make more money during the accumulation phase, and they could get a larger income during the payout phase. However, one downside is that the buyer was exposed to market risk, which means they could lose money. By contrast, the life insurance company assumes the risk of delivering whatever return it has promised with a fixed annuity.

Read More: Fixed vs. Variable

Variable Annuities vs. Fixed Indexed Annuities

Fixed-indexed annuities can be considered a hybrid of a variable annuity and a fixed annuity. Instead of earning a fixed rate of interest, a fixed-indexed annuity allows a consumer to earn interest based on the performance of a stock market index such as the S&P 500, Dow Jones, and Nasdaq, and the life insurance company assumes the risk instead of the annuity owner.

How Variable Annuities Compare

Fixed Index
Principal ProtectionNoYesYesYesYes
Access To PrincipalYesYesYesNoNo
Control Over MoneyYesYesYesNoNo
Tax-Deferred GrowthYesYesYesNoNo
Guaranteed GrowthNoYesYesNoNo
Guaranteed IncomeYesYesYesYesYes
Inflation ProtectionYesYesNoYesYes
Death BenefitYesYesYesYes/NoYes/No
Long-Term Care HelpYesYesYesNoNo

Variable Annuity calculator

Variable annuities can provide guaranteed lifetime income with a guaranteed lifetime withdrawal benefit. Use our annuity calculator to estimate how much guaranteed income for life you can generate.

Next Steps

Variable annuities offer several benefits, such as tax-deferred growth for retirement and lifetime retirement income. However, some risks are also associated with these products, including the potential to lose your retirement savings. Additionally, variable annuities can be expensive products with high fees and charges. If you’re considering a variable annuity for your retirement savings, it’s important to understand the details before deciding. Contact us today if you have any questions or want more information about this investment product.

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Frequently Asked Questions

What is a variable annuity, and how does it work?

Variable annuities are deferred annuity contracts that earn investment returns based on the performance of the underlying investment portfolios known as subaccounts, where you choose to put your money. The return in a variable annuity isn’t guaranteed. The value of the subaccounts you choose could go up or down. If the value goes up, you could make money, but you could lose money if the value goes down. Variable annuities are considered securities, not insurance.

What happens to a variable annuity when I die?

Variable annuities offer a death benefit. If you die during the deferral period, all or some of the annuity’s value is paid directly to your beneficiaries, either in a lump sum or a series of payments over time. The amount is usually the greater of the annuity account value or the minimum guaranteed surrender value. If you die during the income phase after you annuitize the contract, your beneficiaries may receive lump-sum payments, series of payments, or nothing at all, depending on the annuitization payout structure.

What does a variable annuity do?

A variable annuity is a type of annuity that allows the policyholder to invest their money in various investment options. The policyholder can choose how their money is invested and change their investment choices over time. As a result, the value of the annuity will fluctuate depending on the performance of the investments.

Can you lose money in a variable annuity?

It is possible to lose money in a variable annuity if the investments perform poorly.

What is wrong with variable annuities?

Some people believe that variable annuities are too risky because the value of the annuity can go down and up. However, this is true of any investment, and with a variable annuity, you have the potential to earn a higher return than with a traditional fixed annuity. Unfortunately, variable annuities also come with fees ranging between 3% and 4% a year, which eat into your retirement savings.

Is variable or fixed annuity better?

It depends on your circumstances and investment goals. For example, if you are looking for stability and guaranteed income in retirement, a fixed annuity may be better. However, if you are willing to take on more risk in exchange for the potential of higher returns, a variable annuity may be a better option.

When can I withdraw from my variable annuity?

Withdrawals from a variable annuity are available during retirement, starting at 59.5. You may also be subject to a withdrawal penalty if you withdraw funds before age 59 1/2.

How are variable annuities paid out?

Variable annuities are paid out in much the same way as a traditional fixed annuity. You can choose to receive your payments in a lump sum or over a period of time. The amount you receive each month will depend on the performance of the investments within your annuity.

How does a variable annuity work when you retire?

A variable annuity can provide you with a stream of income during retirement. The amount you receive each month will depend on the performance of the investments within your annuity. You can also choose to withdraw from your annuity, although you may be subject to a withdrawal penalty if you withdraw funds before age 59 1/2.

What is the difference between a variable annuity and a mutual fund?

A mutual fund is an investment vehicle that allows you to pool your money with other investors to buy stocks, bonds, or other securities. A variable annuity is an insurance product that allows you to invest your money in various investment options. The value of the annuity will fluctuate depending on the performance of the investments.

What are some of the disadvantages of a variable annuity?

Variable annuities come with fees ranging between 3% and 4% a year, eating into your retirement savings. They also have complex fee structures that can be difficult to understand. Additionally, the value of the annuity can go down and up, which means you could lose money.

What is the difference between a variable annuity and a traditional annuity?

A traditional annuity is an insurance product that provides you with a stream of income during retirement. A variable annuity also provides you with a stream of income during retirement. Still, the amount you receive each month will depend on the performance of the investments within your annuity. Additionally, a traditional annuity is a fixed product, meaning that the payments you receive are guaranteed, while a variable annuity is not.

Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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