Variable Annuity Basics

There are a number of annuity products available. Here's a look at variable annuities.


An annuity is a contract between you and an insurance company. You agree to give the insurance company a certain amount of money and the insurance company agrees to grow it or pay it back to you in increments, or sometimes both.

Fixed vs. Variable Annuity

A fixed annuity is an annuity that grows at a fixed rate over a period of time. A variable annuity, on the other hand, grows at a variable rate depending on the types of investment vehicles the deposits are put in.

The money inside your annuity grows tax-deferred meaning it isn’t taxed until you withdraw it, even if it increases in value.

An annuity can be used as a way to save for retirement. Unlike IRAs and 401Ks, there are no annual contribution limits with a variable annuity (or a fixed annuity). You can contribute as much money to your variable annuity as you can afford and your contract allows.

Immediate or Deferred

Variable annuities are available as immediate or deferred annuities. With an immediate annuity, you give a one-time, lump-sum payment and then begin receiving monthly payments sometime within the next year. The amount of your monthly disbursement is based on current interest rates and your life expectancy.

With a deferred annuity, you delay the date at which you start receiving payments. In the meantime, your annuity continues to grow (or shrink) until you’re ready to make withdrawals. It’s best to wait until after you turn 59 ½ to receive your annuity payments so you avoid early withdrawal penalties. Once you’re ready to withdraw your money, you can take out a lump-sum, make periodic withdrawals until the money is gone, or you can choose to receive regular payments over a period of time.

Contributing to a Variable Annuity

You make contributions to variable annuity during the accumulation phase. When you make your contributions, known as purchase payments, you can specify how much of each payment goes toward various investment options. You can also choose to allocate part of your payments toward a fixed account, which will grow at a fixed rate every year.

You can find out information about the variable annuity’s investment options by reading the prospectus. The prospectus is document the Securities and Exchange Commission (SEC) requires companies to give that details all the facts about the investment.

The Payout Phase

The payout phase is the period of time when you start receiving payments from your variable annuity. You can choose between regular payments or a lump-sum payment. When you choose to receive regular payments, you also choose how long the payments will last, either a set period of time, or an indefinite period of time.

Death Benefit

Variable annuities come with a death benefit that pays your beneficiary if you pass away before the annuity starts making payments to you. Your beneficiary will either receive all the money in your account or a guaranteed minimum amount. You may be able to pay
an extra fee for a “stepped-up” death benefit that allows you to lock-in a guaranteed amount that your beneficiary will receive even if the value of your account falls.

Typical Variable Annuity Fees

Variable annuities are infamous for the fees they charge. It’s important to consider the fees since they reduce the value of your account.

Mortality and expense risk charge is around 1.25% per year and is paid to the insurance company for the risk of taking on the annuity contract.

Administrative fees are about $25 to $30 per year and used for record-keeping and other costs of keeping up your account.

Underlying fund expenses are based on the mutual fund you choose with your variable annuity.

You’ll pay a fee for other benefits you choose with your policy, like the stepped-up death benefit, long-term care insurance, or guaranteed minimum income benefit.

The surrender fee is charged if you withdraw money from your annuity before the payout phase begins. The fee varies.

It’s important to weigh the extra costs associated with variable annuity products to determine if they are right for your unique situation. In a number of cases the benefits outweigh the additional costs, but not for all investors.