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Variable Annuities

A "Variable" annuity is a contract between you and an insurance company. Although it shares many similarities with fixed rate and/or equity-indexed annuities, a variable annuity has three major distinctions from these annuities: risk, fees and often how the death benefits are paid. Setting aside these differences, a variable annuity can look, act and feel much like a more traditional fixed or indexed annuity.

Although issued by insurance companies, variable annuities are not considered solely "insurance products" like fixed annuities. They are considered to be a security, similar to other investments like stocks, bonds or mutual funds, for example. That’s because with a variable annuity you can lose principal, unlike with a fixed annuity, which has no investment risk.

When someone initially deposits money into a variable annuity, the funds are allocated to one or more of the annuity's "subaccounts." These subaccounts are chosen by the annuitant from a menu of options that can range from money market accounts to more aggressive growth funds. Although not identical, these offerings frequently emulate popular mutual funds investments.

A percentage of each deposit is allocated to the selected subaccount based on the annuitant's risk tolerance, goals and overall financial objectives. The annuitant may also make periodic exchanges between subaccounts on a tax-deferred basis, thus, allowing the investment strategy to be adjusted with changes in market conditions or investment objectives. As an example, a person age 45 may have may choose a more aggressive strategy than someone age 60, who would likely select a more conservative strategy given their proximity to retirement age. By being able to exchange funds between subaccounts, the annuitant can make changes to their investment strategy without triggering income taxes on the exchange. This gives the variable annuity a distinct advantage over other investments like stocks or mutual funds, which would otherwise treat such exchanges a taxable event.

Tax-Deferred Growth

One of the many features of a variable annuity is that interest earnings can grow tax-deferred, meaning that no current tax liability is due on interest (or subaccount exchanges) until withdrawn. This gives the holder of a variable annuity an advantage over alternative investments such as stocks, bonds or mutual funds, which are all taxed on interest and dividend distributions as earned.


Like most annuities, variable annuities do have early withdrawal penalties known as "surrender charges," however, these types of policies offer the annuitant a variety of liquidity options when it comes to making withdrawals. For example, should the annuitant need to make a one-time withdrawal or want to use their variable annuity to provide monthly income, he or she can typically withdrawal up to 10% of the surrender value each year, without penalty.

Variable annuities also offer a variety of other income options similar to those offered by immediate annuities. Some may also offer income riders, such as the "Lifetime Income Benefit Rider." While fees are often associated with this particular income option, they are usually justified by higher income payouts and better liquidity options than ordinary immediate annuities. To read more about lifetime income benefit riders, click here.

Two other liquidity options you might find associated with a variable annuity are the nursing home waiver and/or the terminal illness rider. The nursing home waiver allows the annuitant to surrender the contract in full, without penalty, if the annuitant is confined to a nursing home for 90 days or longer. Similarly, the terminal illness rider will waive any type of penalty on surrender in the event the annuitant is diagnosed with a terminal illness. If included, neither of these features usually have any type of fee associated with them.


Variable annuities can be expensive. A typical variable annuity can have anywhere from two to four separate fees and/or expense charges. These charges vary by company and product, but can include Mortality Expenses (M&E) normally ranging from .50 to 1.5%, Administrative Expenses ranging from .10 to .30%, and something called an Investment Expense Ratio which usually ranges from .25 to 2.00% of the total account value. All totaled, these fees can range anywhere from .85 to 3.80% (or higher) of the annual account value and do not include other fees for things like a Lifetime Income Benefit Rider.

Another form of an "indirect" fee are the charges associated with the subaccount. These fees are paid to the investment advisor responsible for making investment decisions affecting the performance of each subaccount. This is similar to an investment manager’s fee in a mutual fund. These expenses include buying and selling securities as well as administering trades for each subaccount. This type of fee is often difficult to assess because it is already calculated into the published investment performance rate for each subaccount.

Death Benefit

One of the standard fees associated with a variable annuity is the Mortality and Expense (M&E) charge. This fee is essentially insurance to guarantee that, regardless of investment performance, at the death of the annuitant, his or her beneficiary will receive the greater of the current account value or a return of the total payments made, less any withdrawals taken over the life of the annuity. Some variable annuities may also include an "enhanced" death benefit for an additional charge. This allows for the death benefit to "lock in" periodically based on investment performance.

Estate Planning

All annuities allow you to name a beneficiary in the event of the annuitant’s death. If properly designated, the proceeds of the annuity bypass probate and go directly to the named beneficiary upon death.

Possible Advantages

Variable annuities give the annuitant the opportunity to participate in stock market like returns. This allows the variable annuity to compete with other investments such as mutual funds. Interest earnings and even subaccount exchanges are considered tax-deferred, until withdrawn. If elected, certain variable annuities allow the annuitant to periodically lock in gains. This can result in a higher death benefit being paid to the beneficiary. Finally, variable annuities guarantee a minimum death benefit, regardless of investment performance or market conditions that could have affected the annuity aversely.

Possible Disadvantages

Like virtually all tax-deferred annuities, variable annuities have early withdrawal penalties should you decide you want all of your money back before the end of the contract term, which is typically a range from 5 to 10 years. However, most variable annuities offer a variety of income withdrawal options, which, if elected, will avoid any early withdrawal penalties. Variable annuities typically have fees up to 3.8% (or higher) on average. These fees are in addition to any rider fees that might be added to the annuity. Fees are paid each year, regardless of investment performance. Additionally, subaccount fees are difficult to assess. Variable annuities can also lose money, including principal.


Variable annuities are considered an alternative to investments like stocks, bonds or mutual funds. While they have the potential to deliver stellar returns, they also come with considerable risk. In general, variable annuities should be utilized where annuitant has a long-term objective, at least 5 to 10 years or more. Advantages such as the ability to pay higher returns or provide tax-deferred growth should be weighed carefully against the disadvantages, such as fees and risks, for example.

As with any annuity, it is important to know what you are purchasing, how it works and the terms of the annuity contract, but this is especially important when considering a variable annuity. To find out more about variable annuities, visit the online publication, "Variable Annuities: What You Should Know." which can be found at the US Securities and Exchange Commission website, We encourage you to read this publication.