Variable Annuity
An annuity whose sub-account values fluctuate with underlying investments; principal is not protected from market loss.
A variable annuity is an annuity contract whose value is held in sub-accounts that function much like mutual funds, so account value rises and falls directly with the performance of the underlying investments. Variable annuities are registered securities sold with a prospectus, and unlike fixed or fixed-indexed contracts, principal is not protected from market loss. Cost is typically layered across several charges that only add up to a meaningful figure when read together.
- —Sub-account values move with the underlying investments; there is no floor against market loss unless a rider is added and funded separately.
- —Variable annuities are securities, sold with a prospectus, and generally require a securities license in addition to an insurance license to sell.
- —Costs stack in layers - mortality and expense charges, administrative charges, fund expenses, and any optional rider charges - and should be summed into one annual figure.
- —A living benefit rider can be attached to guarantee a lifetime withdrawal amount even if the underlying sub-accounts decline, at an additional annual cost.
A variable annuity holds sub-accounts that function much like mutual funds. Values rise and fall with the investments held inside them. Variable contracts are securities and are sold with a prospectus.
Cost structures are typically layered - mortality and expense charges, administrative charges, underlying fund expenses, and any optional rider fees. Reading those layers as one combined annual number is the only reliable way to know what the contract costs.
How the layered cost structure works
A variable annuity's total annual cost is rarely a single disclosed number. It accumulates across several distinct charges, each expressed as its own percentage, and only the sum describes what the contract actually costs each year.
| Charge | What it covers | Typical basis |
|---|---|---|
| Mortality and expense (M&E) | Insurance guarantees and carrier profit margin | Percentage of account value |
| Administrative charge | Recordkeeping and contract administration | Percentage of account value or flat fee |
| Underlying fund expenses | Management of the sub-accounts themselves | Percentage of assets in each fund |
| Optional rider charges | Living benefits, death benefit enhancements | Percentage of account value or benefit base |
Where investment risk sits
Because sub-account values fluctuate directly with markets, a variable annuity without a living benefit rider offers no protection against a decline in account value. Owners choose their own sub-account allocations from a menu the carrier offers, and that allocation - not the annuity wrapper itself - drives most of the variability in returns.
A living benefit rider changes this picture for income purposes only. It can guarantee a lifetime withdrawal amount calculated from a separate benefit base, even if the account value underlying it has declined, but it does not stop the account value itself from falling, and it comes at an additional annual charge.
Tax treatment and access
Growth inside a variable annuity is tax-deferred until withdrawal. Withdrawals follow last-in-first-out ordering in a non-qualified contract, meaning gain is treated as coming out before basis and is taxed as ordinary income, with a possible additional penalty before age 59 and a half.
Access during the surrender period is governed by the same mechanics as other deferred annuities - a free-withdrawal allowance, a declining surrender charge schedule, and in some designs a market value adjustment - though variable contracts do not typically carry an MVA the way fixed and indexed contracts do.
Frequently asked questions
- Can I lose money in a variable annuity?
- Yes. Sub-account values fluctuate with the underlying investments, and account value can decline in a down market. A living benefit rider, if attached and funded, can guarantee a lifetime withdrawal amount independent of account value, but it does not prevent the account value itself from falling.
- Why are variable annuity fees layered instead of a single number?
- The contract combines several distinct components - insurance guarantees, administration, underlying fund management, and optional riders - each priced separately. Reviewing the prospectus and summing these charges into one annual figure is the only reliable way to know the total cost.
- Do I need a securities license to sell a variable annuity?
- Yes. Because variable annuities are registered securities sold with a prospectus, sales generally require both an insurance license and an applicable securities registration, unlike fixed or fixed-indexed annuities.
- What is the difference between a variable annuity and a fixed-indexed annuity?
- A variable annuity's value moves directly with sub-account investment performance and can decline. A fixed-indexed annuity credits interest based on an index's movement but does not expose principal to a negative index period, which instead credits zero.