The Variable Annuity

Shawn Plummer

CEO, The Annuity Expert

What is a Variable Annuity?

Variable annuities are a popular long-term investment plan for retirement. Variable annuities earn returns based on the investment portfolio’s performance (stocks, bonds, mutual funds), also known as a subaccount.

This guide is ideal for:

  • Investors wanting variable annuities explained in more detail.
  • Consumers wanting to invest their savings in the market, but want some protection in case of a stock market crash.
  • Investors wanting an annuity with the highest returns.
  • Use our annuity calculator to get a quote.

How Do Variable Annuities Work?

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Variable Annuity Contract Phases

Since variable annuities are deferred, they have an accumulation period and an optional annuity payout period (annuitization).

Accumulation Phase

Variable annuities earn investment returns based on the investment portfolios’ 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 every day based on the performance of the subaccounts.

However, you may allocate some of your investment choices into a fixed interest rate option guaranteed not to change for a specific amount of time, typically 1 year.

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

Tax-Deferred Growth

Variable annuity taxation is tax-deferred, which means you won’t pay 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.

Pros and Cons: Variable Annuity Benefits and Risks


  • Tax-Deferred Growth for Retirement
  • Lifetime Retirement Income
  • Unlimited Growth Potential


  • Exposure to Market Loss (You can lose your retirement savings.)
  • Expensive Fees and Charges
  • Long Term Contracts

Riders: Variable Annuity Guarantees

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 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 lifetime income is what you seek, save money by purchasing a fixed indexed annuity. The cost of their income rider is a fraction of the cost and could generate more income than a variable annuity.

Variable Annuity Fees and Charges

Variable annuities charge various 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 would expect to pay between $3,000 to $4,000 in fees this year alone.

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 annuities 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 administrative 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.
  • Rider and Benefit Fees: Any additional special features or benefits (riders) offered by some variable annuities 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, may also apply.
  • Market Value Adjustment: Some variable annuities 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 annuity payments (annuitize), your chosen survivors may or may not receive anything depending on the deceased’s chosen annuitized income payout option.

Some variable annuities offer an enhanced death benefit at an additional cost.

Living Benefits

Variable annuities may offer an optional benefit at an additional cost that offers some guarantee regardless of how your subaccounts perform.

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.

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

Guaranteed Minimum Income Benefit

The Guaranteed Minimum Income Benefit (GMIB) guarantees a minimum lifetime income in retirement. This is similar to a Deferred Income Annuity in this insurance world 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 set maximum percentage each year.

How are Variable Annuities Taxed?

Variable annuities are tax-deferred vehicles which means under current tax laws, any guaranteed interest rate or gain in an annuity is not taxable until you begin to receive this income.

The power of tax-deferred 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 totally pre-taxed funds, so when you decide to withdraw any funds from the account, 100% of the income you withdraw will be subject to ordinary income taxes.

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 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 all of the fees and expenses that 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?

Understanding Your Variable Annuity

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

If you find yourself worried or feel that you haven’t purchased what you understood, there is always a feel 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.

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

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

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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 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.

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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