Variable Annuity

Everything You Need to Know About Variable Annuities

(And maybe even a little more)

Variable Annuity

If you search the internet for "retirement planning," Google comes back with 359 million results. That's a whole lot of information, but it all boils down to this. Retirement planning is about building wealth to create income. 

Variable annuities are a financial tool designed exactly for that. Building wealth and creating lifetime retirement income. 

So you want to know about variable annuities? Here’s everything you ever wanted to know, and maybe a little more.

Our independent agent matching tool will find you the best insurance solution in your area. Tell us what you're looking for and we'll recommend the best agents for you. Any information you provide will only be sent to the agent you pick.

First Things First ... What’s a Variable Annuity?

Annuities are policies issued by insurance companies. They pay a regular income for life or for a period of years. You buy a variable annuity policy by making a single payment or a series of payments. Variable annuities are either deferred or immediate.

Variable annuities are either qualified or non-qualified.

  • Qualified annuities are part of a pension plan or IRA. They are purchased with before-tax dollars. Roth-qualified annuities are part of a Roth IRA or pension plan. They are purchased with after-tax dollars. 
  • Non-qualified variable annuities are personally owned and paid for with after-tax dollars.

Owners, Annuitants, and Beneficiaries

A variable annuity policy is a contract between the insurance company and these folks.

The owner has the sole right to the values and payments in the contract. The owner decides who the annuitant and beneficiaries are. The age and sex of the annuitant are how the insurance company determines the amount and when income is paid. The annuitant and owner don't have to be the same. The beneficiary receives the proceeds at the death of the owner or annuitant.

The insurance company issues the policy and has to honor the promises in it. Guarantees in the policy are only as good as the financial ability of the insurance company to pay claims.

Why It's Called Variable

Variable annuities have a selection of investments called subaccount funds. Subaccount funds are similar to mutual funds. Investors can choose from stocks, bonds, and other asset classes. The subaccounts accumulate money on a tax-deferred basis. Money can be transferred between subaccounts without any tax consequences.

The value of variable annuities is represented by units. The value of each unit rises and falls with the investment it represents. The account value of a variable annuity rises and falls based on the value of the units, not because there are more units or fewer units.

On the other hand, the value of fixed annuities is measured by dollars. When the value of a fixed annuity rises or falls, it's because there are more dollars or fewer dollars in the account.

 Basic Variable Annuity Features

  • A menu of investment options: Variable annuities have a selection of investment options that suit many different objectives and strategies.
  • Tax advantages: Capital gains and dividends are not taxed until money is distributed from the annuity. There is no tax on transfers between subaccount.
  • Creditor protection: Most states offer annuities some form of creditor protection. In some cases, it is unlimited protection.
  • Annuity options: Lifetime income based on investment performance, and guaranteed lifetime income options are available.

Optional Variable Annuity Features

  • Guaranteed minimum income benefit (GMIB): This rider provides a minimum amount of lifetime income when they retire regardless of what the account value is. The minimum income is based on the original investment accumulated at an interest rate specified in the policy. Once the option is selected, the owner has no access to policy values.
  • Guaranteed lifetime withdrawal benefits (GLWB): This rider provides a minimum amount of lifetime income when they retire regardless of the account value. Unlike the GMIB, the owner does have access to the account values. Withdrawing money in excess of the guarantee will reduce or eliminate the minimum income.
  • Guaranteed minimum accumulation benefits: This rider guarantees a minimum account value regardless of investment performance. The minimum is usually 100% of the purchase payments after a seven- to ten-year holding period.
  • Enhanced death benefit riders: These protect beneficiaries from down markets. The standard death benefit of a variable annuity is the account value.

How Much Does a Variable Annuity Cost?

Fees and expenses for variable annuities can range from 1.2% to over 4%. Some insurance companies do offer low-cost "no frills" variable annuities for less than .5%. The typical fees and expenses are:

  • Front end sales loads: The front end sales load is deducted from your purchase payment. Most products on the market today don't have a front end sales load.
  • Mortality & expense charges: Asset-based charges for the cost of guaranteed annuity payouts and death benefits.
  • Investment manager fees: These are charges for professional management of subaccount funds.
  • Administrative fees: These are flat fees for transactions.
  • Surrender penalties: Most variable annuities charge a fee if you cash in your contract or withdraw more than 10% of the cash value. Surrender penalties decline to zero over a period of years, usually not more than ten.
  • Rider fees: Asset-based charges for optional income and death benefit riders. 

Building Wealth in a Variable Annuity

Variable annuities are an affordable way the average  investor can take advantage of professional money management and diversification. Variable annuities usually have a wide selection of investment options to choose from. Stock funds, bond funds, real estate, as well as other asset classes are often on the menu. Mutual funds, of course, offer these options as well, so why is a variable annuity different?

Variable annuities are tax-deferred investment vehicles. There is no tax on capital gains and dividends until money is distributed. For investors who regularly rebalance their portfolios between asset classes, tax deferral is important. That's because there is no tax when one investment is sold and another purchased. So instead of the money going to Uncle Sam, it stays in your account and continues to grow. 

Variable Annuity Retirement Income

Variable Income: The assumed rate of interest is what insurance companies use to calculate the initial variable income payments from an annuity. The initial payment is calculated based on your age, sex, the assumed rate of interest, the account value, and the annuity income option that you select. 

If the subaccount funds that you selected perform better than the assumed interest rate, your payment will be higher. If the performance of the subaccount investments that you selected is lower than the assumed interest rate, your payments will be lower.

Variable lifetime income can be attractive for the investor who wants to keep up with inflation and is comfortable with the risk.

Guaranteed Income: All of the annuity income options are available as a fixed guaranteed income. The guaranteed lifetime minimum withdrawal benefit is available as a rider.

The chart below summarizes common variable annuity income options.


During LifetimeAt DeathAdvantagesDisadvantages
Life Pays income for annuitant’s lifeNoneHighest incomeNo refund of unused principle
Life and 10 Years CertainPays income for life, not less than 10 yearsBalance if death occurs before the end of 10 yearsProtection for beneficiariesLower income
Life and 20 Years CertainPays income for life, not less than 20 yearsBalance if death occurs before the end of 20 yearsProtection for beneficiariesLower income
Life wIth Cash RefundPays income for life, payments are at least specified refund amountBalance of refund amountProtection for beneficiariesLower Income
Period CertainPays income for a specified number of yearsBalance of paymentsUseful for certain planning purposesOutliving income
Joint & Survivor 100%Pays income for longer of two livesNo further payments at second deathSurviving spouse continues to receive income for lifeLower Income
Guaranteed Lifetime Withdrawal Benefit Single LifePays income for annuitant’s lifeBalance of accountAccess to account values, death benefitIncome taxed as withdrawals
Guaranteed Lifetime Withdrawal Joint LifePays income for lifetimes of annuitant and second lifeBalance of account at second deathAccess to account, death benefitIncome taxed as withdrawals

Variable Annuity Taxes

Tax treatment for traditional qualified annuities, Roth-qualified annuities, and non-qualified annuities is different.

The chart below summarizes tax treatment of variable annuities.


Non-QualifiedQualifiedQualified/Roth 
ContributionsAfter-tax, unlimitedPre-tax, limits for IRAs and qualified plans applyAfter-tax, limits for IRAs and qualified plans apply
Growth Tax-deferredTax- deferredTax-deferred
Surrender Gain is taxed at ordinary rates.All proceeds taxableTax-free
Annuity Income Partially taxable at ordinary rates100% taxable at ordinary ratesTax-free
Withdrawals Withdrawals are gain first, gain is taxed at ordinary rates.100% taxable at ordinary ratesTax-free
Loans Loans are considered withdrawals, gain first is taxed at ordinary ratesIRA loans not permitted, pension plans may have exceptions for home purchase and loans repaid in five yearsIRA loans not permitted, pension plans may have exceptions for home purchase and loans repaid in five years
Death BenefitsGain is taxed at ordinary rates, proceeds will be taxed as "gain first"Rules for inherited traditional IRAs and qualified plans applyRules for inherited Roth IRAs and plans apply
Sales Proceeds in excess of basis taxed at ordinary ratesN/AN/A
Penalties10% for withdrawals before age 59-1/210% for withdrawals before age 59-1/210% for withdrawals before age 59-1/2, penalty for withdrawals prior to  end of the fifth year

What Happens to the Money in a  Variable Annuity When You Die?

If you die during the deferral period, your beneficiary will receive the account value. If you die during the distribution period, the income option that you selected will determine what the beneficiary will receive.

Some companies offer a minimum guaranteed death benefit equal to the purchase payment. There are also optional riders to step up or increase the death benefit based on a formula. The formula can be the purchase payments accumulated at an interest rate, or the highest previous account value.

What if the Insurance Company Goes Bankrupt?

Insurance companies that sell variable annuities are regulated by each of the 50 state insurance departments. These departments have financial standards for licensed companies. Each state has guarantee funds to reimburse policyholders if the insurance company fails. The limits for each state are different.

Variable annuity products are regulated by the states, the SEC, and FINRA. The subaccounts in variable annuities are separate from the insurance company, and not subject to the claims of their creditors. That said, strong financial ratings are important.

Financial ratings of insurance companies are available from A.M. Best, Fitch, Moody’s, and Standard & Poor.


Highest Ability to
Meet Obligations
Medium Ability to
Meet Obligations
Lowest Ability to
Meet Obligations
A.M. BestA++ to A-B++ to B-C++ to C-
Moody’sAaa to AaA to BaaBa to Caa
S&PAAA to ABBB to BCCC to C
FitchAAA to AA-A+ to BBB-BB+ to CC

Is a Variable Annuity Right for Me?

Variable annuities are financial tools. Whether they are right for you depends on the job you want them to do. Here are some considerations:

  • Retirement plans: Are you contributing the maximum to your employer's retirement plans?
  • Tax-deferred growth: This is a major benefit of annuities. Is tax control important to you? Can you benefit from tax-deferred growth?
  • Tax-free transfer: Transfer between subaccounts is ideal for investors who regularly rebalance their portfolios. Would you take advantage of this feature?
  • What type of investor you are: Are you willing to take on risk?
  • Variable annuities have surrender and tax penalties: Do you have adequate resources for emergencies and other short-term needs?
  • Variable annuities: These can guarantee an income for life. Do you want a fixed guaranteed income instead of income that may benefit from market returns?

What Should I Look for in a Variable Annuity?

Ratings: Financial strength of the insurance company is important. Review the ratings with your independent insurance agent.

Surrender charges: The surrender period is usually five to seven years. If it's longer, make sure you understand why. In any event, it should not be longer than ten years.

Fees and expenses: Fees and expenses with optional riders can be over 3%. Make sure you know what you are buying and why. Be sure to look at several companies and compare the fees.

What's Next?

Variable annuities can be an important part of your retirement plan. While they have many features and benefits, they are not for everyone. Talk to an independent insurance agent. They can help you decide if a variable annuity is right for you.

Use our independent agent matching system to find the best insurance plan in your area. You tell us what you’re looking for, and our technology will recommend the best agents for your needs. Any information you give us will only be sent to the agents you pick.

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