What is a Variable Annuity?

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Contributor, Benzinga
October 17, 2022

An annuity allows for a stream of income in the future and the peace of mind that comes with knowing that you will not outlive your assets and savings in retirement. Several different types of annuity contracts exist, one of them being variable annuities. Variable annuities are different from the other primary type of annuity, fixed annuities, as payments received can become larger if the investment aspects of the annuity are doing well or smaller if the investments are doing poorly.

What is a Variable Annuity?

A variable annuity is an insurance contract between an insurance company and you. You purchase an annuity contract through a single payment or through a series of payments over a period of time, which becomes your principal upon which your annuity is based. The payments you make then allow you to receive income payments for the rest of your life or for a specific period of time depending on your annuity’s contract terms.  

A variable annuity offers a number of different investment options, which can grow on a tax-deferred basis. You can choose from a few different types of variable annuities that offer different options mainly related to the payouts you receive. 

The two contributing elements of a variable annuity include the principal payment, which is the amount that you pay into the annuity contract when you initially sign on, and the returns on the investments made through the annuity. The cash flow of a variable annuity is highly reliant on the investments made and can cause the annuitant to make gains or losses in accordance with the market. 

Variable annuities are different from fixed annuities because they offer a different payout structure. When you invest in a fixed annuity contract, the amount of money that you’ll receive each payment period is the same. On the other hand, when you purchase a variable annuity contract, your payouts may vary depending on the performance of the underlying investment. While fixed annuities provide you with consistent, easily predictable payments, they may come with an opportunity cost when compared to a variable annuity if the market is doing well. 

Types of Variable Annuities

Deferred annuity: A deferred annuity is the more popular type of variable annuity. With this type of annuity, you pay a lump sum or payments over a period of time in exchange for a stream of income in the form of payments in future. 

The payments don’t begin immediately, which is why most investors use deferred annuity payments during retirement as income that supplements other retirement income, such as Social Security payments or their IRA proceeds. Deferred annuities can also be paid out in one lump sum in the future instead of in a stream of income payments if you would prefer that and your insurance provider offers this choice.      

Immediate annuity: Immediate annuities are insurance contracts that allow you to make payments or a lump sum payment in exchange for a guaranteed income that starts immediately after you sign onto your contract. Sometimes referred to as an income annuity or a single-premium immediate annuity, immediate annuity payments are determined by your age, interest rates and the amount of time the payments are being paid for. 

Payments usually begin within a month of purchasing the annuity, but you can choose how often you wish to receive the payments. Payments can be made monthly, quarterly or annually depending on your needs and your preferences. Payments are typically fixed but can sometimes be based on an underlying portfolio of securities’ performance if the insurer offers the option.  

Advantages of a Variable Annuity

  • Tax-deferred growth: Variable annuities grow on a tax-deferred basis, meaning that you do not have to pay federal taxes on the income and gains through investments until you make a withdrawal, receive income payments or are paid a death benefit. 
  • A steady income stream: The guaranteed stream of income payments from a variable annuity is a major advantage as you don’t have to worry about whether you’ll outlive your assets and run out of money during retirement. 
  • Guaranteed death benefit: A death benefit is a guaranteed payment that is paid to the beneficiary in the case the annuitant, the person who purchased the annuity, dies before payments begin. The death benefit will vary depending on the insurance company, but it will be an amount equal to the amount invested or higher if the contract’s value is higher according to the recent policy anniversary statement. 
  • Creditors cannot touch these funds: Creditors and other debt collectors are not able to touch the funds in an annuity. The money is considered private, which means that no one can look at it, so it is safe from being seized or garnished by creditors or other debt collectors. 

Drawbacks of Variable Annuities

  • Risk: A variable annuity carries more risk than a fixed annuity. Fixed annuities have a fixed interest rate whereas variable annuity returns are based on the underlying investments. Variable rates mean you could experience a greater loss in the case that the investments lose value.  
  • Early withdrawal fees: All annuities have surrender fees, which are fees that you’ll pay if you wish to withdraw money from your annuity before your specified payment plan. You could have a financial emergency or have something come up that requires a significant lump sum of money, but no matter what the reason, annuity companies charge early withdrawal fees. 
  • Other fees: Variable annuity contracts are subject to a number of fees in addition to withdrawal fees — and these fees can be substantial. Variable annuities have the most fees out of all other types of annuities. Some fees that you may need to pay include investment fees, contract fees and mortality and expense fees. Because of the fees adding up over time, they can take a significant chunk of change away from your stream of income payments. With a variable annuity, you’re just hoping that the returns will be able to outweigh the cost of any fees. 

Is a Variable Annuity Right for You?

Though variable annuities can come with tax advantages, they can also be comparatively expensive investments to sign onto. Before you invest in an annuity, you may want to consider maxing out other avenues for retirement investing, especially your 401(k) account. Traditional 401(k) accounts also come with tax advantages by reducing your total taxable income, meaning that you’ll pay less in state and federal taxes when April rolls around.

Additionally, many employers also offer 401(k) match programs, which allow you to maximize your contributions without saving more of your own money. Of course, if you’ve already maxed out your 401(k) account for the year, a variable annuity can be a viable secondary savings vehicle. Consider speaking with a financial professional or planner for advice specific to your current investment strategy.

If you’re interested in annuities, you might also be interested in gold and silver investing. You can buy gold and silver coins or bars from a platform like Augusta Precious Metals or set up a Gold or Silver IRA. Some people might buy into both. You want to expand and diversify your investments as much as possible, and considering all your options can go a long way.

Frequently Asked Questions


What is wrong with variable annuities?


The potential problems that you might face with variable annuities depend on what you are looking to get out of your annuity contract. Variable annuities are ultimately designed to be a long-term investment, so they aren’t a particularly good choice for older men and women who are already closer to retirement and who will need to tap into their funds soon after they sign onto their contract. The benefits that come with a variable annuity also come at a cost, so if the benefits don’t outweigh the costs for you, then variable annuities may not be the best option for you. Finally, if the underlying investment of your annuity contract decreases in value, you could see diminished returns when compared to other investment products   


Can you lose money in a variable annuity?


The payments from a variable annuity are reliant on the insurance company being able to make those payments to you. If the insurance company goes under, then your payments may cease to be made. While this is unlikely, it’s still a possibility, and you risk losing your money. Variable annuities can also be volatile, as they rise and fall with the market. You could end up losing money comparatively speaking if the investment returns are lacking, but this loss is only in the context of an opportunity cost.  


What is the difference between an annuity and a variable annuity?


The difference between an annuity and a variable annuity is that annuity cannot go up and down because it is fixed. But a variable annuity goes up and down depending on the returns of the mutual funds that make up the investment.


About Sarah Horvath

Sarah is an expert in the insurance, investing for retirement and cryptocurrency space.