Unlocking the Potential of Variable Annuities for Smart Investments

An in-depth guide to understanding variable annuities, their advantages and disadvantages, and how they compare to fixed annuities. Ideal for those looking into strategic retirement planning.

What is a Variable Annuity?

A variable annuity is a type of annuity contract whose value can fluctuate based on the performance of an underlying portfolio of sub accounts. These sub accounts operate similarly to mutual funds but lack ticker symbols for easy tracking.

Variable annuities differ significantly from fixed annuities, which offer a guaranteed return. Instead, they provide an opportunity for higher returns tied to market performance, albeit with a corresponding risk of potential losses.

Key Takeaways

  • The value of a variable annuity depends on the performance of an underlying portfolio of sub accounts selected by the annuity owner.
  • Fixed annuities offer guaranteed returns.
  • Variable annuities present potential for high returns and greater income but come with the risk of account value reduction.

Understanding Variable Annuities

The value of a variable annuity hinges on two components: the principal amount paid into the annuity and the returns delivered by the underlying investments over time.

One prevalent type of variable annuity is the deferred annuity, often used for retirement planning. It offers regular income beginning at a future date. Immediate annuities, meanwhile, start paying income right away.

Variable Annuity Basics

An annuity can be purchased with either a lump sum or a series of payments. For deferred annuities, this phase is the accumulation phase. When the annuity owner initiates income payments, it enters the payout phase. Note that once income distribution begins, additional withdrawals may not be permitted.

Variable annuities serve as long-term investments due to withdrawal restrictions. Generally, one annual withdrawal is allowed during the accumulation phase; however, withdrawals during the surrender period often incur surrender fees. Also, early withdrawals before age 59½ may result in a 10% tax penalty.

Variable Annuities vs. Fixed Annuities

Variable annuities, introduced in the 1950s, serve as alternatives to fixed annuities, allowing investments in mutual funds offered by insurers. The benefit is the potential for higher returns and a larger income during the payout phase, but with the downside of market risk—which can lead to losses.

Variable Annuity Advantages and Disadvantages


  1. Tax-Deferred Growth: Investment gains are not taxed until income is received or withdrawals are made, similar to retirement accounts like IRAs and 401(k)s.
  2. Tailored Income Streams: Adaptable to individual needs.
  3. Guaranteed Death Benefit: Beneficiaries receive a guaranteed payout if the owner dies before the payout phase.
  4. Protected Funds: Annuity funds are generally protected from creditors.


  1. Higher Risk: Underlying investments might lose value.
  2. Surrender Fees: Early withdrawals can lead to hefty fees, particularly before age 59½, inclined with a 10% tax penalty.
  3. High Fees: Charges include investment management fees, mortality fees, administrative fees, and costs for additional riders—all accumulating to detract from overall returns.

What Is an Annuity?

An annuity is an insurance product promising future income based on funds invested by the owner. Post-purchase, the funds are invested until a pre-determined disbursement period, determined by the owner’s age.

Variable vs. Fixed Annuities Earnings

There is no definite answer. While variable annuities offer higher earning potential due to fluctuations with underlying investments, they might also incur losses and fees that eat into profits. Fixed annuities provide a lower but stable income, making it crucial to closely evaluate options when choosing an annuity.

Are Annuities FDIC-insured?

No, annuities aren’t insured by the Federal Deposit Insurance Corp. (FDIC). However, state guaranty associations provide some level of protection if the insurance company defaults.

The Bottom Line

Before investing in a variable annuity, it’s imperative to thoroughly review the prospectus to ascertain expenses, risks, and methods of calculating gains or losses. Keep in mind the array of fees that could cumulatively diminish long-term returns compared to other investment types.

Related Terms: annuities, deferred annuities, fixed annuities, immediate annuities.


  1. U.S. Securities and Exchange Commission. “Variable Annuities: What You Should Know”, Page 3 (Page 5 of PDF).
  2. U.S. Securities and Exchange Commission. “Variable Annuities: What You Should Know”, Pages 5–7 (Pages 7–9 of PDF).
  3. U.S. Securities and Exchange Commission. “Variable Annuities: What You Should Know”, Page 10 (Page 12 of PDF).
  4. U.S. Securities and Exchange Commission. “Updated Investor Bulletin: Variable Annuities”.
  5. Federal Reserve Bank of Chicago. “How Much Risk Do Variable Annuity Guarantees Pose to Life Insurers?”
  6. U.S. Securities and Exchange Commission. “Variable Annuities: What You Should Know”, Page 6 (Page 8 of PDF).
  7. Annuity.org. “Annuities”.

Get ready to put your knowledge to the test with this intriguing quiz!

--- primaryColor: 'rgb(121, 82, 179)' secondaryColor: '#DDDDDD' textColor: black shuffle_questions: true --- ## What is a primary feature of a Variable Annuity that differentiates it from a Fixed Annuity? - [x] Variable payouts based on the performance of underlying investments in sub-accounts - [ ] Guaranteed fixed payouts regardless of market performance - [ ] Predetermined payout intervals - [ ] Absence of investment options ## Which of the following describes a sub-account in the context of a Variable Annuity? - [ ] A separate savings account for annuity payments - [ ] A bank account managed independently - [x] An investment portfolio within the annuity where the buyer's funds are allocated - [ ] A subsidiary company managing the annuity ## What does the accumulation phase refer to in a Variable Annuity? - [ ] The period during which annuity payments are distributed - [ ] The period when investment gains are locked in - [x] The phase where contributions are made and account value accumulates based on investments - [ ] The mandatory withdrawal phase ## What kind of investment returns can be expected from a Variable Annuity? - [ ] Fixed returns determined at inception - [ ] Guaranteed annual returns - [x] Variable returns based on market performance - [ ] No returns until annuitization ## How can the payout phase of a Variable Annuity be described? - [ ] Contributions continue during payout - [x] Period when the accumulated funds are converted into periodic payments to the annuitant - [ ] Lump-sum payout of the entire account value - [ ] Investment continues with no withdrawals ## What is an important risk associated with Variable Annuities? - [ ] Loss of life insurance during payments - [x] Investment risk due to market volatility - [ ] Locked-in low interest rates - [ ] Pre-determined inflation adjustments ## Which of the following is a typical benefit of a Variable Annuity? - [x] Tax-deferred growth on earnings - [ ] Unlimited contributions - [ ] High guaranteed interest rates - [ ] Fixed investment returns ## Variable Annuities often come with which of the following features? - [ ] Mandatory investment in company stock - [ ] Guaranteed returns without market exposure - [x] Optional living benefits like income riders - [ ] Lack of death benefit options ## How does the death benefit in a Variable Annuity work? - [ ] Comes as a lump-sum based on initial contributions only - [ ] Always equals the highest historical account value - [x] Typically ensures beneficiaries receive at least the total contributions minus withdrawals - [ ] Offers no flexibility to beneficiaries ## What type of investors are typically attracted to Variable Annuities? - [ ] Those seeking exposure to a single stock - [x] Those looking for retirement income with potential growth tied to market performance - [ ] People uninterested in market performance - [ ] Investors avoiding all forms of risk