A variable annuity is a long-term financial contract between you and an insurance company designed to help you save for retirement and, if you choose, convert those savings into a stream of income payments later in life. Unlike traditional savings accounts or certificates of deposit, a variable annuity allows you to invest your premium payments into a selection of investment options called "sub-accounts," which function similarly to mutual funds. The value of your annuity can go up or down based on how these investments perform in the market.
Think of it like a retirement savings vehicle with an insurance wrapper. You put money in, that money gets invested according to your choices, and it grows (or shrinks) based on market performance. Later, you can choose to receive regular payments for a set period or even for the rest of your life. The "variable" part means your account value and potentially your income payments can vary depending on investment performance.
Variable annuities were created to address several retirement planning challenges:
Longevity Risk: Many people worry about outliving their savings. Variable annuities can provide guaranteed income for life, meaning you can't outlive your payments even if you live to 100 or beyond.
Tax-Deferred Growth: During the accumulation phase (while you're building your account value), your investment earnings grow tax-deferred. You don't pay taxes on gains until you withdraw the money. This can allow your money to compound more effectively than in taxable accounts.
Market Participation with Protection Options: Variable annuities let you participate in market growth through various investment options while also offering optional riders (additional features you pay for) that can protect against market losses or guarantee minimum income levels.
Death Benefit for Beneficiaries: Most variable annuities include a death benefit, meaning if you pass away before annuitizing (converting to income payments), your beneficiaries receive at least the amount you invested, minus any withdrawals, even if the market has performed poorly.
Variable annuities are generally designed for individuals who:
- Have already maxed out other tax-advantaged retirement accounts (like 401(k)s and IRAs)
- Are seeking additional tax-deferred growth opportunities
- Want to participate in market growth but also want access to optional guarantees
- Are in their 40s, 50s, or early 60s with a long-term investment horizon
- Are comfortable with market risk and understand that their account value can fluctuate
- Won't need access to their money before age 59½ (to avoid tax penalties)
- Are looking for a way to convert retirement savings into guaranteed lifetime income
- Have a higher risk tolerance and want investment flexibility
Variable annuities work best for people who understand investing, can tolerate market volatility, and are using them as part of a broader retirement strategy.
Variable annuities may not be appropriate for individuals who:
- Need access to their money in the short term (within 5-10 years)
- Cannot tolerate market risk or seeing their account value decline
- Haven't maxed out lower-cost retirement accounts like 401(k)s or IRAs first
- Are under age 40 and have decades before retirement (may have better options)
- Are over age 75 and looking to start a new contract (limited time to benefit from tax deferral)
- Are looking for completely guaranteed returns with no market risk
- Cannot afford the fees associated with variable annuities
- Are looking for liquidity and easy access to cash
- Have limited retirement savings and cannot afford surrender charges
Variable annuities come with complexity, fees, and restrictions that make them unsuitable for many people. They're not a one-size-fits-all solution.
There are three main types of annuities, and it's important to understand the differences:
Variable Annuities (this product): Your money is invested in sub-accounts that fluctuate with the market. You bear the investment risk, but you also have the potential for higher returns. Your account value and potentially your income payments can go up or down.
Fixed Annuities: Your money earns a guaranteed interest rate set by the insurance company. There's no market risk—your principal is protected and you know exactly how much interest you'll earn. Growth is typically lower but predictable.
Indexed Annuities (Fixed Indexed Annuities): Your returns are linked to a market index (like the S&P 500) but with protection against losses. You get a portion of market gains (subject to caps and participation rates) but your principal is protected if the market goes down. They fall between fixed and variable in terms of risk and potential return.
The key difference: Variable annuities offer the most investment control and growth potential, but they also carry the most risk to your principal. You can lose money in a variable annuity if your investments perform poorly.
Imagine Susan, a 58-year-old marketing director who has maxed out her 401(k) and IRA contributions. She has an additional $100,000 from a recent inheritance that she wants to invest for retirement but also wants to ensure her adult children receive something if she passes away unexpectedly.
Susan purchases a variable annuity and invests $100,000 into various sub-accounts—some in stock funds, some in bond funds, and some in international markets. Over the next five years, she doesn't take any withdrawals and lets her investments grow.
During this time, the market performs well in years one, two, and four, but there are downturns in years three and five. By the time Susan is 63, her account value has grown to $115,000 due to overall positive market performance.
Then, unexpectedly, Susan passes away in a car accident at age 63, before she had planned to start receiving income payments from the annuity.
Here's what happens: Because Susan's variable annuity includes a standard death benefit, her beneficiaries (her two children) receive the full account value of $115,000, tax-deferred to them (they'll pay ordinary income tax when they withdraw it, but there's no loss of value due to her death).
If the market had performed poorly instead, and her account value had dropped to $85,000 at her death, most variable annuities with a standard death benefit would still pay her beneficiaries the greater of her account value or her original investment ($100,000), protecting them from market losses.
This example illustrates how the death benefit provides a safety net for your beneficiaries, ensuring they receive at least what you put in (minus any withdrawals you took), even if markets decline.
Variable annuities do accumulate cash value (called "account value" or "contract value"), which represents the total value of your investments in the sub-accounts, minus any fees and withdrawals.
Imagine Michael, a 62-year-old self-employed consultant who purchased a variable annuity 12 years ago with a $75,000 premium. He chose a diversified mix of stock and bond sub-accounts. Over the years, despite market ups and downs, his account value has grown to $130,000.
Michael is still working and doesn't need income from the annuity yet, but his daughter is getting married and needs help with wedding expenses. He wants to access some of his annuity's cash value.
Here's what happens: Michael contacts his insurance company and requests a partial withdrawal of $15,000. Because he's over age 59½, he won't face the 10% IRS early withdrawal penalty. However, he will pay ordinary income tax on the $15,000 because it represents earnings that have been growing tax-deferred.
Michael's account value drops from $130,000 to $115,000 (minus any withdrawal charges, depending on his surrender period). He uses the money to help with the wedding, and his remaining $115,000 continues to stay invested and grow tax-deferred for his future retirement.
This example shows that the cash value in a variable annuity can be accessed if needed, providing some flexibility. However, it's important to understand that:
- Withdrawals before age 59½ typically incur a 10% IRS penalty plus ordinary income taxes
- Withdrawals during the surrender period (usually 6-10 years) may incur surrender charges from the insurance company
- Withdrawals reduce your account value and future growth potential
- Withdrawals are taxed as ordinary income, not capital gains
Variable annuities are designed primarily for long-term retirement savings, not as emergency funds. The cash value is there and accessible, but there are consequences to accessing it early.
Variable annuities offer several potential benefits:
- Tax-Deferred Growth: All investment earnings grow without annual taxation, potentially allowing your money to compound more effectively over time.
- Unlimited Contributions: Unlike IRAs and 401(k)s, there are no annual contribution limits (though your total premium may be limited by the insurance company).
- Investment Flexibility: You can typically choose from dozens of sub-accounts covering various asset classes, allowing you to build a diversified portfolio tailored to your risk tolerance.
- Lifetime Income Options: You can convert your account value into guaranteed income payments for life through annuitization, eliminating longevity risk.
- Optional Guarantees: Through additional riders (for a fee), you can add protections like guaranteed minimum income benefits, guaranteed minimum withdrawal benefits, or enhanced death benefits.
- Death Benefit: Beneficiaries typically receive at least your original investment (minus withdrawals), protecting them from market losses.
- Professional Management: Sub-accounts are managed by professional investment managers, similar to mutual funds.
Variable annuities also come with important tradeoffs:
- Market Risk: Your account value can decrease if your investments perform poorly. Unlike fixed annuities, there's no guarantee of principal protection (unless you purchase specific riders).
- Higher Fees: Variable annuities typically have multiple layers of fees including mortality and expense risk charges, administrative fees, sub-account management fees, and rider fees. Total annual costs can range from 2-3.5% or more.
- Surrender Charges: If you withdraw more than the penalty-free amount during the surrender period (often 6-10 years), you may face surrender charges ranging from 5-10% of the withdrawn amount.
- Complexity: Variable annuities are complicated products with many moving parts, making them difficult for many consumers to fully understand.
- Ordinary Income Tax: All withdrawals are taxed as ordinary income (not capital gains), which may be at a higher rate than long-term investment gains.
- Loss of Step-Up in Basis: Unlike inherited stocks or mutual funds, beneficiaries don't receive a step-up in cost basis. They pay ordinary income tax on the entire gain.
- Irrevocable Annuitization: Once you annuitize and begin receiving lifetime payments, you typically cannot access your principal as a lump sum.
In a variable annuity, your cash value (called account value) grows based on the performance of the investment sub-accounts you select. Here's how it works at a high level:
- Your Contributions: When you make premium payments, that money is allocated to the sub-accounts you choose—these might include stock funds, bond funds, balanced funds, or other investment options.
- Market-Based Growth: Each sub-account's value fluctuates daily based on the performance of its underlying investments, just like a mutual fund. If your chosen investments perform well, your account value increases. If they perform poorly, your account value decreases.
- Tax-Deferred Accumulation: All gains, dividends, and interest earned inside your variable annuity grow tax-deferred. You won't receive a 1099 form each year for these earnings, and you won't pay taxes on them until you make withdrawals.
- Fee Deductions: Various fees are automatically deducted from your account value—typically on a quarterly or annual basis. These fees reduce your overall growth.
- Compound Growth (or Loss): Over time, your gains can earn their own gains (compounding), or your losses can compound as well. This is why investment selection and asset allocation are critical.
- Rebalancing and Transfers: Most variable annuities allow you to transfer money between sub-accounts (rebalance your portfolio) without triggering taxes, giving you flexibility to adjust your strategy.
Unlike cash value life insurance, which has guaranteed growth components and more predictable accumulation, variable annuity cash value is entirely dependent on market performance and your investment choices. This creates opportunity for greater growth but also significant risk of loss.
- Account Value: The current market value of your investments in the variable annuity sub-accounts, representing what your contract is worth at any given time. This value fluctuates daily based on investment performance and fees.
- Annuitization: The process of converting your account value into a guaranteed stream of regular income payments for a specified period or for life. Once annuitized, you typically cannot access your principal as a lump sum.
- Beneficiary: The person or entity you designate to receive the death benefit from your variable annuity when you pass away.
- Benefit Base: A value used to calculate your guaranteed withdrawal amount under living benefit riders. It's often different from (and higher than) your account value and is not typically available as a lump sum withdrawal.
- Cash Value: Another term for account value—the total value of your investments inside the variable annuity, available for withdrawal or surrender.
- Death Benefit: The guaranteed amount that your beneficiaries will receive when you die, typically at least equal to your total contributions minus any withdrawals (though it can be higher if you purchased enhanced death benefit riders).
- Fixed Annuity: A type of annuity that provides guaranteed interest rates and principal protection, with no market risk. Your money grows at a rate set by the insurance company.
- Fixed Indexed Annuity: An annuity whose returns are linked to a market index (like the S&P 500) but with principal protection. You receive a portion of market gains (subject to caps) but your principal is protected from losses.
- Longevity Risk: The risk of outliving your retirement savings—running out of money before you die.
- Premium: The money you pay into your variable annuity, either as a single lump sum or through multiple payments over time.
- Rider: An optional feature you can add to your variable annuity contract for an additional fee, such as guaranteed minimum income benefits or enhanced death benefits.
- Sub-Account: Investment options within a variable annuity that function similarly to mutual funds. Your premium is invested in sub-accounts you select, and their value fluctuates based on market performance.
- Surrender Charge: A penalty fee charged by the insurance company if you withdraw more than the penalty-free amount during the surrender period (typically the first 6-10 years of the contract).
- Surrender Period: The time period (usually 6-10 years) during which surrender charges apply if you withdraw more than the penalty-free amount from your variable annuity.
- Tax-Deferred Growth: Investment earnings that grow without being taxed annually. You only pay taxes when you withdraw the money, allowing your investment to compound more effectively.
- Underwriting: The process of evaluating risk when issuing an insurance contract. Variable annuities typically do NOT require medical underwriting, unlike life insurance products.
- Variable Annuity: A long-term insurance contract where you invest in sub-accounts that fluctuate with the market, offering tax-deferred growth and optional guarantees for lifetime income.
Biblical stewardship requires us to be neither recklessly unplanned nor foolishly trapped by complicated financial products we don't understand. It calls us to: Plan Wisely (recognize real risks), Seek Understanding (fully comprehend any financial commitment before proceeding), Count the Cost (consider all fees, restrictions, and alternatives), Get Counsel (seek advice from knowledgeable, trustworthy advisors), and Prioritize Simplicity (when possible, choose simpler solutions that you can understand and manage).
Variable annuities can be a legitimate planning tool for specific situations, but they're not universally appropriate. The wise steward takes the time to understand whether this complex product truly serves their family's needs or whether simpler, less expensive alternatives might better honor God with the resources He has provided.
God has entrusted you with resources to steward. Whether a variable annuity belongs in your plan depends on your specific situation, but the decision should be made with prayer, understanding, and godly counsel—not pressure, confusion, or fear.
Coverage examples are for educational purposes only. Actual premiums and eligibility depend on age, health, tobacco use, underwriting class, coverage amount, product design, carrier guidelines, and state regulations.
The information provided herein is for educational purposes only. Our licensed insurance and financial professionals are qualified to provide personalized advice during individual consultations. This general content should not replace a personal consultation regarding your specific financial situation. Biblical references are from the New International Version (NIV) unless otherwise noted.
Here's what typically happens when you purchase a variable annuity:
Step 1 - Initial Consultation: You meet with a licensed insurance agent or financial advisor who explains variable annuities, assesses whether they're appropriate for your situation, and discusses your goals, risk tolerance, and time horizon.
Step 2 - Product Selection: Your agent helps you select a specific variable annuity contract from an insurance company, reviewing the available sub-accounts, fees, riders, and contract features.
Step 3 - Application Completion: You complete an application that includes personal information, beneficiary designations, premium amount, and investment selections. There's typically no medical underwriting required for variable annuities (unlike life insurance).
Step 4 - Suitability Review: The insurance company reviews your application to ensure the variable annuity is suitable for your age, financial situation, investment objectives, and risk tolerance. This is a regulatory requirement.
Step 5 - Premium Payment: You provide your premium payment, which can be a single lump sum (single premium) or a series of payments over time (flexible premium). Payment can come from a check, wire transfer, or direct rollover from another retirement account.
Step 6 - Free Look Period: Once the contract is issued, you typically have 10-30 days (depending on your state) to review the contract and cancel it for a full refund if you change your mind.
Step 7 - Accumulation Phase: Your money is invested in your chosen sub-accounts, and your account value begins to fluctuate based on market performance. You can usually make additional contributions, transfer between sub-accounts, and adjust your allocations.
Step 8 - Distribution Phase (Future): When you're ready, you can begin taking withdrawals, annuitize the contract for guaranteed income, or leave the money to continue growing tax-deferred.
Unlike life insurance products, variable annuities typically do NOT require medical underwriting. There are no health questions, no medical exams, and no blood tests. This is because the insurance company is not primarily taking on mortality risk—you're taking on the investment risk.
However, there IS a suitability and compliance review:
Suitability Determination: The insurance company (and in some cases, a regulatory body) reviews your application to ensure the variable annuity is suitable for you based on:
- Your age
- Your income and net worth
- Your investment objectives
- Your risk tolerance
- Your time horizon
- Your tax situation
- Your liquidity needs
Age Restrictions: Most insurance companies won't issue new variable annuity contracts to people over age 75-80 because there's insufficient time to benefit from the tax-deferral features.
Financial Qualification: You may need to demonstrate that you have sufficient income, net worth, and liquid assets to justify the purchase and that tying up money in an annuity won't create financial hardship.
Documentation Requirements: You'll need to provide identification, tax information, and possibly documentation of the source of funds (especially for large premiums).
The review process typically takes 1-3 weeks, though it can be faster if everything is in order.
Variable annuities have multiple layers of fees that can significantly impact your returns:
- Mortality and Expense (M&E) Risk Charge: This fee (typically 1-1.5% annually) compensates the insurance company for providing the death benefit guarantee and bearing the risk that annuitants will live longer than expected. It's deducted from your account value.
- Administrative Fees: These cover the cost of recordkeeping, customer service, and contract maintenance. They typically range from $25-50 per year or 0.10-0.25% of account value.
- Sub-Account Management Fees: Each investment sub-account charges its own management fee (like a mutual fund expense ratio), typically ranging from 0.5-2% annually. These fees vary based on the sub-accounts you choose.
- Rider Fees: Optional guarantees like guaranteed minimum income benefits (GMIB), guaranteed minimum withdrawal benefits (GMWB), or enhanced death benefits come with additional fees, typically 0.5-1.5% of your benefit base or account value annually.
- Surrender Charges: If you withdraw more than the penalty-free amount during the surrender period (usually the first 6-10 years), you'll pay a surrender charge, typically starting at 7-10% in year one and declining by 1% per year until it reaches zero.
- Total Annual Costs: When you add up all these fees, variable annuities typically cost 2-3.5% or more per year, which can significantly reduce your net investment returns over time.
- Premium Taxes: Some states charge a premium tax (typically 1-3.5%) on annuity purchases, which is a one-time cost.
Variable annuities offer numerous optional riders that provide additional guarantees or features for an extra fee:
- Guaranteed Minimum Income Benefit (GMIB): Guarantees a minimum amount of lifetime income when you annuitize, regardless of how your investments perform. You typically must wait 7-10 years and then annuitize to access this benefit.
- Guaranteed Minimum Withdrawal Benefit (GMWB): Allows you to withdraw a certain percentage of your benefit base each year (typically 5-7%) for life, even if your account value drops to zero. You maintain control of your account value.
- Guaranteed Lifetime Withdrawal Benefit (GLWB): Similar to GMWB but explicitly designed for lifetime income. Guarantees you can withdraw a certain percentage of your benefit base annually for as long as you live.
- Enhanced Death Benefit Riders:
- Return of Premium: Guarantees beneficiaries receive your total contributions, even if account value is lower
- Highest Anniversary Value: Locks in the highest account value on a contract anniversary and guarantees beneficiaries receive that amount
- Earnings Protection: Guarantees beneficiaries receive your contributions plus a minimum growth rate (e.g., 5% annually)
- Long-Term Care / Chronic Illness Riders: Provide enhanced withdrawals or income if you become chronically ill or need long-term care.
- Asset Allocation Programs: Automated rebalancing programs that adjust your investments to maintain target allocations or reduce risk as you age (usually for a fee).
Tradeoffs: Each rider costs 0.25-1.5% of your benefit base or account value annually. The more riders you add, the higher your total fees. Some riders also have restrictions on which sub-accounts you can invest in.
Variable annuities come with several important restrictions:
- Surrender Period Limitations: During the surrender period (typically 6-10 years), you can usually withdraw up to 10-15% of your account value annually without surrender charges. Withdrawals beyond this penalty-free amount incur surrender charges.
- Early Withdrawal Penalties: Withdrawals before age 59½ typically incur a 10% IRS penalty (in addition to ordinary income taxes), with limited exceptions for death, disability, or substantially equal periodic payments.
- Annuitization Restrictions: Once you annuitize and begin receiving lifetime income payments, you typically cannot reverse the decision or access your principal as a lump sum. This decision is permanent.
- Investment Transfer Limitations: Many contracts limit how frequently you can transfer money between sub-accounts (e.g., 12-20 transfers per year) to prevent market timing abuses.
- Rider Restrictions: Living benefit riders often require you to invest in certain sub-accounts or limit your investment choices to more conservative options to maintain the guarantee.
- Excess Withdrawal Consequences: Taking withdrawals beyond your guaranteed amounts may reduce or eliminate living benefit guarantees. For example, taking a large withdrawal from a GLWB contract may permanently reduce your guaranteed income amount.
- No Loss Deductions: If you surrender your variable annuity at a loss, you cannot deduct that loss on your taxes unless you fully surrender the contract and have no other annuity contracts with that insurance company.
- Market Risk: There is no protection against market losses in the base variable annuity unless you purchase specific riders. Your account value can decline significantly.
Variable annuities have unique tax treatment:
- Tax-Deferred Growth: All investment earnings grow tax-deferred during the accumulation phase. You won't pay taxes on gains, dividends, or interest until you make withdrawals.
- Ordinary Income Tax on Withdrawals: All withdrawals are taxed as ordinary income (not capital gains), which may be at a higher rate than long-term capital gains rates. The IRS uses LIFO (Last In First Out) accounting, meaning earnings are withdrawn first and taxed, then your principal is returned tax-free.
- 10% Early Withdrawal Penalty: Withdrawals before age 59½ typically incur a 10% IRS penalty on the taxable portion (earnings), in addition to ordinary income taxes. Exceptions exist for death, disability, and substantially equal periodic payments.
- No Required Minimum Distributions (RMDs) While Living: Unlike IRAs and 401(k)s, non-qualified variable annuities (those not held in a retirement account) do NOT require you to take RMDs at age 73.
- Death Benefit Taxation: When you die, your beneficiaries pay ordinary income tax on the gain in the contract. They do NOT receive a step-up in cost basis like they would with stocks or mutual funds. This can create a significant tax burden.
- Partial 1035 Exchanges: You can exchange one annuity for another tax-free under IRC Section 1035, but you cannot do a partial exchange. The entire contract must be exchanged.
- State Premium Taxes: Some states charge a premium tax when you purchase the annuity, which is a one-time cost.
- No Loss Carry-Forward: Losses inside a variable annuity cannot offset other investment gains on your tax return.
Your variable annuity evolves through several phases:
- Accumulation Phase (Years 1-10+): During this period, your account value grows (or shrinks) based on investment performance. You're building your retirement savings and paying annual fees. You cannot take penalty-free withdrawals until age 59½ without incurring IRS penalties. Surrender charges typically apply during the first 6-10 years.
- Surrender Period Expiration (Year 6-10): Once the surrender period ends, you have full liquidity to withdraw your funds without surrender charges, though taxes and IRS penalties (if under 59½) still apply.
- Pre-Retirement/Age 59½ (Ongoing): Once you reach age 59½, you can take withdrawals without the 10% IRS penalty. Your money continues growing tax-deferred if you don't withdraw it.
- Retirement/Distribution Phase (Age 60+): Many owners begin taking systematic withdrawals at this stage, either by annuitizing for guaranteed lifetime income or by taking periodic withdrawals from their account value. If you have living benefit riders, you can activate guaranteed income streams.
- Annuitization (Optional): If you choose to annuitize, your account value is converted into a guaranteed stream of income payments based on your age, gender (in some states), interest rates, and payout option selected. Once annuitized, you can no longer access the principal as a lump sum.
- Death: Upon your death, if you haven't annuitized, your beneficiaries receive the death benefit (typically the greater of your account value or your contributions, depending on the rider). Beneficiaries must pay income taxes on the gains.
- Post-Death Distribution: Beneficiaries typically must withdraw the inherited annuity within 5-10 years or take lifetime payments, depending on their relationship to you and the contract terms.
Many consumers make these errors:
- Buying Without Understanding: Many people purchase variable annuities without fully understanding the fees, restrictions, surrender charges, and market risk. They're surprised later when they realize they cannot easily access their money or when they see how much fees have reduced their returns.
- Not Comparing Fees: Variable annuity fees vary significantly between contracts. Failing to shop around and compare total annual costs can result in paying 1-2% more per year than necessary, which dramatically impacts long-term returns.
- Purchasing in a Retirement Account: Buying a variable annuity inside an IRA or 401(k) is often unnecessary because these accounts already provide tax deferral. You end up paying variable annuity fees for a benefit you already have. Exceptions exist for guaranteed income riders.
- Over-Reliance on Guarantees: Some consumers believe living benefit riders provide complete protection. In reality, these guarantees often come with significant restrictions, reduced investment flexibility, and high costs that may negate the benefit.
- Withdrawing Too Early: Taking large withdrawals during the surrender period or before age 59½ triggers significant penalties that can erode your account value by 15-25% or more.
- Ignoring Total Fee Impact: Many owners don't realize that 3% annual fees can reduce their account value by 40-50% over 20-30 years compared to lower-cost alternatives.
- Not Rebalancing Investments: Some owners set their asset allocation once and never review it, potentially taking on too much or too little risk as they age.
- Choosing Inappropriate Beneficiaries: Naming your estate as beneficiary (rather than individuals) can create tax problems and eliminate stretch distribution options for heirs.
- Comparing to Investments Inappropriately: Some people compare variable annuities to stocks or mutual funds without accounting for the insurance features, guarantees, and different tax treatment.
Before buying a variable annuity, ask these questions:
- "What are the TOTAL annual fees, including all riders, sub-account fees, and M&E charges?" (Get a specific percentage.)
- "What is the surrender charge schedule, and how long is the surrender period?"
- "What is the penalty-free withdrawal amount each year during the surrender period?"
- "How does this variable annuity compare to simply investing in low-cost index funds in a taxable account?"
- "If I already have an IRA or 401(k), why should I buy this in addition to those accounts?"
- "What happens if I need to access this money before age 59½ or before the surrender period ends?"
- "What investment options (sub-accounts) are available, and what are their individual expense ratios?"
- "What happens to my account if the insurance company goes bankrupt?"
- "What living benefit riders are available, and exactly what do they guarantee? What are the restrictions?"
- "What is the death benefit, and how will my beneficiaries be taxed?"
- "Can I exchange this annuity for another one later if I'm not satisfied?" (1035 exchange)
- "What is your commission on this sale?" (Understand advisor incentives)
- "Can you show me an illustration comparing the variable annuity to alternative strategies over 10, 20, and 30 years?"
- "What happens if the stock market crashes right after I invest?"
The insurance company backing your variable annuity matters significantly:
Claims-Paying Ability: The insurance company guarantees your death benefit and any living benefit riders you purchase. If the company becomes insolvent, these guarantees may be worthless or reduced.
State Guaranty Associations: Most states have guaranty associations that provide limited protection if your insurance company fails. However, state guaranty associations are NOT the same as FDIC insurance for bank accounts. They are not pre-funded safety nets and work very differently. Coverage limits vary significantly by state (typically $100,000-$500,000 for annuities) and apply per insurance company, not per contract. This means if you have $400,000 in a variable annuity and your state's limit is $250,000, you could lose $150,000 if the insurance company fails. State guaranty associations are a last-resort safety net, not a substitute for choosing a financially strong insurance company from the start. Before committing large sums to a variable annuity, check your specific state's guaranty association website to understand your actual coverage limits.
Financial Strength Ratings: Before purchasing, review the insurance company's ratings from agencies like A.M. Best, Moody's, Standard & Poor's, and Fitch. Look for companies rated A or better.
Sub-Account Protection: The money you invest in sub-accounts is held in a separate account that is legally separated from the insurance company's general assets. If the company fails, your sub-account investments are protected because they're not part of the company's assets available to creditors.
Long-Term Commitment: Variable annuities are decades-long commitments. You want to be confident the insurance company will still be strong and solvent 20-30 years from now when you need to rely on their guarantees.
Due Diligence: Research the company's history, financial stability, customer service reputation, and any regulatory issues before committing your money.
- 1035 Exchange: A provision in the tax code that allows you to exchange one annuity contract for another without triggering immediate taxation on the gains. Named after Internal Revenue Code Section 1035.
- Administrative Fee: A charge (typically $25-50 per year or 0.10-0.25% of account value) that covers recordkeeping, customer service, and contract maintenance costs.
- Asset Allocation: The process of dividing your investments among different asset classes (stocks, bonds, etc.) to manage risk and potential returns.
- Free Look Period: A state-mandated period (typically 10-30 days) after purchasing an annuity during which you can cancel the contract and receive a full refund.
- Guaranteed Lifetime Withdrawal Benefit (GLWB): An optional rider that guarantees you can withdraw a certain percentage of your benefit base annually for life, even if your account value drops to zero.
- Guaranteed Minimum Income Benefit (GMIB): An optional rider that guarantees a minimum amount of lifetime income when you annuitize, regardless of how your investments perform.
- Guaranteed Minimum Withdrawal Benefit (GMWB): An optional rider that allows you to withdraw a certain percentage of your benefit base each year, even if your account value declines, while maintaining control of your remaining account value.
- LIFO (Last In First Out): The IRS accounting method for annuity withdrawals, which treats earnings as coming out first (and being taxable) before your principal is returned tax-free.
- Living Benefit Rider: An optional feature that provides guarantees related to withdrawals or income while you're still alive, such as GMWB or GLWB riders.
- Mortality and Expense (M&E) Risk Charge: An annual fee (typically 1-1.5%) that compensates the insurance company for providing the death benefit guarantee and bearing the risk that annuitants will live longer than expected.
- Penalty-Free Withdrawal Amount: The amount you can withdraw each year during the surrender period without incurring surrender charges, typically 10-15% of your account value annually.
- Required Minimum Distribution (RMD): The minimum amount you must withdraw annually from most retirement accounts starting at age 73. Non-qualified annuities do NOT have RMDs while the owner is living.
- Step-Up in Cost Basis: A tax benefit where inherited assets are revalued to their current market value, eliminating capital gains taxes on appreciation during the deceased's lifetime. Annuities do NOT receive this benefit.
- Sub-Account Management Fee: The annual fee charged by the investment manager of each sub-account within your variable annuity, similar to a mutual fund expense ratio (typically 0.5-2%).
- Suitability Review: A regulatory-required evaluation to ensure a financial product is appropriate for a consumer's specific situation, financial condition, and objectives.
Variable annuities represent a "tower" of complexity, with multiple layers of fees, restrictions, surrender periods, riders, and tax consequences. Many people sign contracts without fully "estimating the cost"—not just the financial costs, but the cost of: Lost Liquidity (your money is tied up for years), Accumulated Fees (2-3.5% annually can reduce your retirement wealth by hundreds of thousands), Tax Inefficiency (ordinary income tax rates on all withdrawals, and no step-up in basis for heirs), Complexity (ongoing management and understanding required), and Opportunity Cost (what else could you have done with this money?).
The person who purchases a variable annuity without understanding these costs is like the builder who starts construction without calculating expenses. They may find themselves trapped in a contract they don't understand, paying surrender charges to exit, or realizing too late that their account value has been eroded by fees and poor investment performance.
Biblical wisdom calls us to: Sit Down and Calculate (before committing, thoroughly understand ALL costs), Consider Whether You Can "Finish" (do you have the discipline to hold this contract for 20-30+ years?), Seek Expert Counsel (don't rely solely on the person selling the product), Compare Alternatives (run the numbers honestly), and Avoid Hasty Decisions (high-pressure sales tactics should raise red flags).
God honors careful, prayerful stewardship. He is not honored by financial decisions made in haste, confusion, or fear. Whether a variable annuity belongs in your financial plan should be determined only after you've "sat down and estimated the cost"—both seen and unseen.
Remember: A variable annuity is not a spiritual decision, but your stewardship of God's resources IS a spiritual matter. Approach this decision with prayer, wisdom, and a commitment to managing His resources with integrity and understanding.
Coverage examples are for educational purposes only. Actual premiums and eligibility depend on age, health, tobacco use, underwriting class, coverage amount, product design, carrier guidelines, and state regulations.
The information provided herein is for educational purposes only. Our licensed insurance and financial professionals are qualified to provide personalized advice during individual consultations. This general content should not replace a personal consultation regarding your specific financial situation. Biblical references are from the New International Version (NIV) unless otherwise noted.
The Misunderstanding: Many people believe variable annuities are universally beneficial retirement vehicles that everyone should consider.
The Clarity: Variable annuities are specialized financial tools designed for specific situations, not universal solutions. They work best for individuals who have already maxed out other tax-advantaged retirement accounts, have a long time horizon, can tolerate market risk, and value optional guarantees enough to pay significant fees for them.
For most people, prioritizing 401(k) contributions, IRAs, HSAs, and low-cost index funds in taxable accounts will provide better long-term results with lower fees and more flexibility. Variable annuities should only be considered after these foundations are in place.
Variable annuities are complex and expensive. They're appropriate for perhaps 10-20% of retirement savers who have specific needs for the guarantees and features they provide, not for the majority of consumers.
The Misunderstanding: Some people believe that because variable annuities grow tax-deferred, they're escaping taxation on their investment gains.
The Clarity: Tax deferral is not the same as tax avoidance. You're simply delaying taxes until you withdraw the money, not eliminating them. In fact, you may pay MORE in total taxes with a variable annuity because:
- All withdrawals are taxed as ordinary income (potentially 22-37% federal) rather than the lower capital gains rates (0-20%) that apply to stocks and mutual funds.
- Your heirs don't get a step-up in cost basis when they inherit the annuity, meaning they pay ordinary income tax on all the gains.
- You're paying 2-3.5% annual fees, which significantly reduces your account value over time, leaving you less money to spend in retirement even after accounting for tax deferral.
Tax deferral can be valuable if you're in a high tax bracket now and expect to be in a lower bracket in retirement, but it's not a guaranteed win. Run the numbers carefully and compare after-tax, after-fee outcomes.
The Misunderstanding: Many consumers believe that variable annuities protect their principal from market losses, similar to fixed annuities or CDs.
The Clarity: In a standard variable annuity without additional riders, your principal is NOT protected from market losses. Your account value can and will decline if your chosen investments perform poorly. You bear 100% of the investment risk.
The only principal protection in a base variable annuity is the death benefit, which typically guarantees your beneficiaries will receive at least your contributions (minus withdrawals) even if the account value is lower.
You CAN purchase optional riders like guaranteed minimum withdrawal benefits (GMWB) or guaranteed minimum income benefits (GMIB) that provide some protection, but these:
- Cost an additional 0.5-1.5% per year
- Often restrict your investment choices to more conservative options
- May have complex rules about withdrawals and access
If principal protection is your primary goal, a fixed annuity or guaranteed investment may be more appropriate than a variable annuity.
The Misunderstanding: Some people believe variable annuities are as liquid as bank accounts or brokerage accounts and that they can withdraw their money whenever needed without consequences.
The Clarity: Variable annuities are long-term contracts with significant restrictions on access:
- Surrender Charges (Years 1-10): If you withdraw more than the penalty-free amount (typically 10-15% per year) during the surrender period, you'll pay surrender charges of 5-10% of the withdrawn amount.
- IRS Penalties (Before Age 59½): If you withdraw money before age 59½, you'll pay a 10% IRS penalty on any earnings, plus ordinary income taxes.
- Living Benefit Restrictions: If you have guaranteed income riders, taking withdrawals beyond the guaranteed amount may permanently reduce your benefits.
Example: If you invest $100,000 in a variable annuity at age 50 and need $40,000 two years later for an emergency:
- You might pay an 8% surrender charge = $3,200
- You might pay a 10% IRS penalty on the earnings portion = potentially $1,500+
- You pay ordinary income taxes on the earnings
- Your total cost for accessing your own money could be $5,000-$10,000+
Variable annuities are designed for long-term retirement savings, not emergency funds or short-term goals. Only invest money you won't need for at least 10-15 years.
The Misunderstanding: Some consumers believe that because variable annuities offer unique benefits like guaranteed income and death benefits, the fees are justified and don't significantly impact long-term results.
The Clarity: Fees are perhaps the most important factor in determining your variable annuity's performance. A 3% annual fee difference between a variable annuity and a low-cost index fund can reduce your ending account value by 40-50% over 25-30 years.
Example Scenario:
Person A invests $100,000 in a variable annuity with 3% total annual fees
Person B invests $100,000 in low-cost index funds with 0.2% annual fees
Both earn 8% annual returns (before fees) for 25 years
After 25 years:
- Person A has approximately $332,000 (8% return - 3% fees = 5% net)
- Person B has approximately $624,000 (8% return - 0.2% fees = 7.8% net)
Person B has nearly DOUBLE the money, even though both had the same gross returns. The 2.8% annual fee difference cost Person A $292,000 over 25 years.
Even accounting for the insurance benefits and guarantees in the variable annuity, this is a massive difference. Fees compound against you just like returns compound for you.
Always ask for total annual fees as a single percentage, compare them to alternatives, and understand that seemingly small percentage differences create enormous dollar differences over decades.
The Misunderstanding: Some people believe that converting their variable annuity into lifetime income payments (annuitizing) is the primary or best way to use the product.
The Clarity: Annuitization is ONE option, but it's not always the best choice and comes with significant tradeoffs:
What Annuitization Means: When you annuitize, you permanently exchange your account value for a guaranteed stream of income payments (monthly, quarterly, or annually) for a specific period or for life. Once annuitized, you cannot access your principal as a lump sum—the decision is irreversible.
Tradeoffs:
- Loss of Liquidity: You can no longer access your principal for emergencies, opportunities, or changing needs
- Loss of Control: The insurance company keeps any remaining principal when you die (unless you chose a period certain or joint-life option)
- Inflation Risk: Most annuitization options provide fixed payments that lose purchasing power over time
- Opportunity Cost: If you live only a few years after annuitizing, you may receive far less than you could have by taking systematic withdrawals
Better Alternatives: For many people, using guaranteed lifetime withdrawal benefit (GLWB) riders or simply taking systematic withdrawals from their account value provides more flexibility while still meeting income needs. These options allow you to maintain control of your principal and adjust your withdrawals as needed.
Annuitization should be carefully considered with professional guidance and compared to alternative strategies before making this permanent decision.
The Misunderstanding: Some people believe variable annuities are superior to cash value life insurance for retirement planning because they're specifically designed as retirement vehicles.
The Clarity: Variable annuities and cash value life insurance serve different purposes and have different strengths. Neither is universally "better"—they're tools for different situations:
Variable Annuities Advantages:
- Unlimited contribution amounts
- Designed specifically for accumulation and income
- Multiple investment options with active management
- Guaranteed lifetime income options without mortality risk
Cash Value Life Insurance Advantages:
- Includes death benefit protection for family
- Policy loans and withdrawals may be tax-free (under certain conditions)
- Some policies offer guaranteed minimum growth
- No 10% IRS penalty before age 59½
- May offer more favorable estate planning treatment
- Generally lower fees than variable annuities
The Right Tool for the Right Job:
- If you need life insurance protection AND want to build cash value, cash value life insurance may be more appropriate
- If you've already secured life insurance needs and want additional tax-deferred growth with market participation, variable annuities might make sense
- If you want guaranteed lifetime income without mortality risk, annuitization or income riders provide unique benefits
Many successful retirement plans include BOTH life insurance and annuities playing different roles. The key is understanding what problem you're trying to solve and choosing the tool that best addresses that specific need.
The Misunderstanding: Some consumers believe that purchasing living benefit riders like GMWB (Guaranteed Minimum Withdrawal Benefit) or GLWB (Guaranteed Lifetime Withdrawal Benefit) means they cannot lose money in their variable annuity.
The Clarity: Living benefit riders provide guarantees about INCOME, not about your account value. Your account value can still decline significantly, even to zero, while your guaranteed income continues. Here's how it actually works:
Two Separate Values:
- Account Value: The actual cash value of your investments, which fluctuates with the market
- Benefit Base: The amount used to calculate your guaranteed withdrawal amount (often not a number you can actually access as a lump sum)
Example:
You invest $100,000 in a variable annuity with a GLWB rider that guarantees you can withdraw 5% of your benefit base annually for life. The rider costs 1.25% per year.
Year 1-10: Markets perform poorly and your total fees are 3.25% per year
Your account value drops to $60,000
However, your benefit base for calculating withdrawals might still be $100,000
You can withdraw $5,000 per year (5% of $100,000) for life, even though your account value is only $60,000
What This Means:
- You LOST $40,000 in account value
- You can take $5,000/year guaranteed income, but at this rate it would take 12 years to recoup your original investment
- If you wanted to surrender the contract and take the remaining cash, you'd only get $60,000
- You didn't "lose" your income guarantee, but you definitely lost money in real account value
Living benefit riders protect your income floor—they don't protect against market losses or guarantee you'll get your principal back as a lump sum. Understanding this distinction is critical before purchasing these expensive riders.
- After-Tax Return: Your investment return after accounting for all taxes paid. Variable annuities may have lower after-tax returns than taxable investments despite tax deferral because withdrawals are taxed as ordinary income.
- Capital Gains Tax: A tax on profits from the sale of investments. Long-term capital gains (on investments held more than one year) are taxed at preferential rates (0-20%), which are lower than ordinary income tax rates. Variable annuity withdrawals do NOT receive capital gains treatment.
- Fee Drag: The negative impact that annual fees have on investment returns over time. Even seemingly small percentage differences in fees can result in massive differences in ending account values due to compounding.
- Guaranteed Lifetime Withdrawal Benefit (GLWB): A rider that guarantees you can withdraw a set percentage of your benefit base annually for life, regardless of account value. It protects income but not principal.
- Guaranteed Minimum Income Benefit (GMIB): A rider that guarantees a minimum amount of income when you annuitize, regardless of investment performance, typically requiring a waiting period and annuitization to access.
- Guaranteed Minimum Withdrawal Benefit (GMWB): A rider that guarantees you can withdraw a certain percentage of your benefit base for a specified period, even if your account value declines.
- Illiquid: Not easily converted to cash without significant cost or penalty. Variable annuities are illiquid due to surrender charges and tax penalties.
- Ordinary Income Tax: Tax on income taxed at your marginal tax rate (10-37% federal), which is typically higher than capital gains rates. All variable annuity withdrawals are taxed as ordinary income.
- Opportunity Cost: The potential benefit you give up by choosing one option over another. Investing in a high-fee variable annuity has an opportunity cost—the better returns and flexibility you might have had with lower-cost alternatives.
- Systematic Withdrawals: Taking regular, scheduled withdrawals from your account value rather than annuitizing. This approach maintains flexibility and control of your principal.
Also: "The simple believe anything, but the prudent give thought to their steps." - Proverbs 14:15 (NIV)
The Proverbs verse warns us that "the simple believe anything"—they accept claims at face value without investigation. The prudent person, however, "gives thought to their steps." They ask hard questions, compare alternatives, calculate total costs, and consider consequences before acting.
Variable annuities are not inherently good or bad—they're tools that serve specific purposes in specific situations. But they require understanding, discernment, and honest evaluation. A person who purchases a variable annuity based on misunderstandings will eventually face the consequences: lost flexibility, eroded wealth from excessive fees, tax surprises, or feeling trapped in a complex contract they never truly understood.
Biblical stewardship calls us to: Reject Simplistic Thinking (don't accept any financial product's claims without verification), Seek Truth (ask questions until you truly understand), Calculate Real Costs (look beyond surface-level benefits), Consider Long-Term Consequences (how will this impact your family in 10, 20, or 30 years?), Get Independent Counsel (seek advice from advisors who are not compensated by the sale of the product), and Pray for Wisdom ("If any of you lacks wisdom, you should ask God, who gives generously to all without finding fault, and it will be given to you" - James 1:5).
God has entrusted you with resources to steward on His behalf. Whether you should include a variable annuity in your financial plan is not a question of whether the product itself is "sinful" or "righteous"—it's a question of whether it serves your family's needs efficiently and whether you understand it well enough to steward it wisely.
Don't let complexity, fear, or sales pressure drive your decision. Instead, pursue understanding, seek godly counsel, and make your decision from a position of knowledge and peace. That's the path of the prudent—and the path that honors God with the resources He has given you to manage.
Coverage examples are for educational purposes only. Actual premiums and eligibility depend on age, health, tobacco use, underwriting class, coverage amount, product design, carrier guidelines, and state regulations.
The information provided herein is for educational purposes only. Our licensed insurance and financial professionals are qualified to provide personalized advice during individual consultations. This general content should not replace a personal consultation regarding your specific financial situation. Biblical references are from the New International Version (NIV) unless otherwise noted.