Variable annuities can be very attractive to investors for several reasons. They enable you to potentially benefit from market upside by investing in mutual-fund like sub-accounts. They also provide protection in a down market, and come with various optional annuity riders — such as death benefits to provide for your heirs, guaranteed minimum income benefits that guarantee a minimum rate of growth (often as high as 5% annually), and lifetime income benefits that guarantee you a regular monthly, quarterly, or annual payment for your lifetime, even if your account balance goes to zero. Follow these links to learn more, and research variable annuities at your own pace.

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What is a Variable Annuity?

A variable annuity is a contract between you and an insurance company. You open an account with funds typically earmarked for your retirement. The insurance company invests your money in a selection of mutual fund-like investments (called “sub-accounts”). Your account value can grow or shrink with the underlying investments, just like with a mutual fund (hence the term “variable”). But with a variable annuity, the insurance company provides insurance on your investment in the event that market performance is poor and your account balance decreases (we will elaborate on how your investment is insured in the next section, “The Insurance Side of Variable Annuities”).

One of the advantages of variable annuities is that, like retirement plans such as 401ks and IRAs, all capital in an annuity grows and compounds tax-deferred until you begin making withdrawals. But unlike retirement plans, there is no limit to how much you can invest in annuities.

The Insurance Side of Variable Annuities

With a variable annuity, the insurance company provides insurance on your investment in the event that market performance is poor and your account balance decreases. There are many different types of insurance on your variable annuity investment — some of which are included in the annuity at no extra cost, and some of which are optional and come with an additional fee (these are called “riders” to your annuity).


The most basic insurance feature that comes with a variable annuity is called annuitization. Annuitization refers to the process by which, if you elect, your account value is converted into a stream of payments, for a specific period of time or for the rest of your life. When you annuitize a variable annuity contract, you forfeit your account value in return for these guaranteed payments. The insurance company calculates your payments using an algorithm that considers factors such as your age, your initial investment premium, and the annuity account value at the time of annuitization. Annuitization is rarely invoked, but could be considered if an investor’s account value plummeted at a time when he or she needed income from the annuity.

Death Benefits

Another basic insurance feature of most variable annuities is called death benefits. Death benefits are designed to insure and preserve your investment for the purpose of passing on to heirs. There are multiple types of death benefits, but typically they insure that when you die, your heirs will receive at least as much money as you invested into the annuity, less any withdrawals you took from your account. Death benefits are a popular way of providing investors with the piece of mind that regardless of market performance, your heirs will receive at least your initial investment.

Living Benefits

The third basic insurance feature of most variable annuities is called living benefits. Just as death benefits insure your investment for your heirs, living benefits insure your investment for your own use should your account value decline significantly. For example, currently one of the most popular types of living benefits is a lifetime income benefit, which guarantees you a stream of income that you cannot outlive while still allowing you to access your principal, if needed.

The Tax Advantage Aspect of Variable Annuities

Variable annuities are very similar to 401(k)s and IRAs in how they are taxed. Money invested in annuities grows tax-deferred, just like 401(k)s and IRAs. And if you transfer money between you annuity sub-accounts, or move from one annuity to another through a 1035 exchange, your investment is not taxed. When and if you start taking income from the annuity (typically after you retire), your withdrawals are taxed as regular income, just like with distributions from a 401(k) or IRA. However, unlike 401(k)s and IRAs, which have annual limits on how much you can contribute, there is no limit on how much you can invest in an annuity.

Variable Annuity Fees

There are essentially three types of fees you should be aware of when investing in a variable annuity: surrender charges should you withdraw funds early; the annual fees on the core annuity and any optional riders; and penalties imposed by the IRS if you withdraw funds prior to the age of 59 1/2.

Surrender Charges

Most annuities come with a surrender period of three to nine years. This is a period during which the insurance company expects you will let your money grow and not make withdrawals in excess of 10% per year. If you take withdrawals in excess of 10% per year before the surrender period is over, the insurance company will impose a surrender penalty on the excess withdrawals. Surrender penalties decrease over time – for example, an annuity with a standard seven-year surrender period may impose a fee of 8% on withdrawals made in the first year, but only 1% for withdrawals made in the 7th year. Note that the 10% annual penalty-free withdrawal is typical of most annuities, but not all.

Annual Fees
ME&A Fees

Just as you pay an annual fee for your auto insurance or homeowner’s insurance, base annuity contracts have an annual fee, called ME&A fees. This stands for Mortality, Expense, and Administrative fees. The industry average for M&E fees is about 1.25%, whereas 1.65% is high and anything below 1% is considered to be low. The industry average for Administrative fees is 0.15%. In sum, ME&A fees vary depending on the contract and features, but should not exceed 2% of the account value (and are often far less). There are also annual fees on optional riders, such as lifetime income benefits or enhanced death benefits. These fees also vary based on the type of benefit, but are rarely above 2% and often far less.

Maintenance Charges

The industry average is $35. Typically the maintenance charges are waived on accounts above $50,000.

Living & Death Benefit Annual Fees

The industry average is 1.10% for a living benefit that typically guarantees a 5% return. The industry average is 0.40% for a death benefit that guarantees the greater of 5% compounded or the highest contract anniversary locking in on the anniversary following the 80th birthday. On average there is no cost for return of principal only (it is included in M&E charges).

The Four Basic Types of Variable Annuity Contracts

When choosing a base variable annuity contract, each insurance company typically allows you to choose between one and four “flavors” of their product:

  • Core — this product comes with the company’s standard surrender period, usually about 7 years.
  • No Surrender – this product has no surrender period and hence no withdrawal penalties. However the annual fees are typically higher in exchange.
  • Short Surrender – these products have a short surrender period, usually 3 or 4 years. But they also typically have higher annual fees and lower guaranteed returns.
  • Bonus — A bonus annuity adds an additional percentage to your premium (often as high as 5%, so if you invest $100,000 your account value immediately goes to $105,000). But in return for this bonus, this type of annuity has the longest surrender period – typically eight to nine years.

Comparing Variable Annuity Features

The table below summarizes the primary features of variable annuities — click on any category to find the most competitive products we’ve fount in the market.

Living Benefit RidersGuaranteed Minimum Income Benefits (GMIBs) guarantee the greater of the actual value, 5-7% compounded annual interest (annuitized), or the highest contract anniversary value (annuitized).

Lifetime Income Benefits (LIBs) allow you to take withdrawals from 4-8% per year for your entire lifetime, regardless of your account value…

Guaranteed Account Value Benefits (GAVs) guarantee your original investment, give you market upside, and allow you to take your investment as a lump sum after a certain period of time.

  • Compare annuities and annuity riders that are among the best value in the industry.
Death Benefit Riders
Investment Strategies & Asset Allocation Models
  • Compare annuities that have historically high performing investment strategies.

Things to Look for in Variable Annuities


Pay attention to fees, but more importantly compare the fund choices available and their performance on a net basis to their benchmark index and the category. Far too often people are so concerned with fees that they miss many of the best mutual fund and variable annuities. Compare like funds and sub-accounts on an apples-to-apples comparison, i.e. large-cap growth versus large-cap growth, small-cap value versus small-cap value. Then pick the funds with the best net (after fees) performance.

Surrender Charges

Most annuities allow you to withdraw either your interest earnings or up to 15% per year without a penalty. However, most annuities also have a surrender charge — a penalty for making an early withdrawal above the free withdrawal amount. Typically this surrender charge decreases over a seven-year period.

For investors who may need spur-of-the-moment access to their money, there are annuities without surrender charges (no-surrender or level load annuities) — these annuities have no penalty or charge for early withdrawal. (That said, even with a no-surrender annuity investors under the age of 59 ½ are subject to a 10% federal excise tax as well as ordinary income taxes on any gains. You can avoid any taxes or penalties, however, by making a 1035 Tax-Free Exchange to another annuity, regardless of age. )

Ask if there is a surrender charge on the variable annuity in which you are interested, and if so the surrender charge schedule. The average surrender charge is seven years long and decreases by 1% per year over seven years (7,6,5,4,3,2,1,0). Surrender charges are also referred to as CDSC (Contingent Deferred Sales Charge). The charges include but are not limited to fees and commissions paid to brokers and agents, and other costs associated with issuing the policy.

As a rule of thumb, a seven-year commitment period should not be a problem in most cases since you shouldn’t be investing in equities for short periods of time (less than ten years) and an annuity is considered to be a long-term investment. Also, most variable annuities allow for at least a 10% annual penalty-free withdrawal, so if you are taking income this should be more than enough at virtually any age.
Where the surrender charge could be a problem is if you are tied up in an inferior annuity and you want out. In such a case you would then have to pay a penalty if it is within the surrender period. That said, there are a number of bonus annuities that will pay you 3% to 7% as an up-front bonus that will more than offset a normal surrender charge in most cases. Be aware that these bonus annuities tend to have a slightly longer surrender period averaging eight to nine years and they may also have higher fees.

Financial Strength Ratings

An annuity is only as good as the insurance company that issues it. It is important to consider the financial strength ratings of the insurance company issuing the annuity. We recommend that you purchase only annuities that are rated in the top 3 with A.M. Best, Moody’s, and Fitch.

Annuity FYI Articles about Variable Annuities

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