Variable Annuity
A variable annuity is an insurance contract whose value moves with the performance of investment subaccounts chosen by the consumer. Subaccounts function like mutual funds — equity, bond, balanced, sector — but exist inside the annuity's tax-deferred wrapper. Because the consumer bears investment risk, variable annuities are dual-regulated: they are insurance products subject to state regulation AND securities subject to federal regulation by the SEC, requiring a prospectus, statement of additional information, and an SEC-registered selling agent. Most variable annuities are sold with optional living benefit riders (typically a Guaranteed Lifetime Withdrawal Benefit, or GLWB) and death benefit riders that guarantee minimum outcomes despite market performance.
A 58-year-old allocates $250,000 to a variable annuity with a 60% equity / 40% bond subaccount mix. He adds a GLWB rider that guarantees a 5% withdrawal beginning at age 65 from the higher of the actual account value or the rider's benefit base. The rider charge is 1.25% per year. If markets perform well, his account grows above the benefit base and he withdraws 5% of the higher account value. If markets are flat or down, the GLWB guarantees his withdrawal anyway.
Why it matters
Variable annuities are the most structurally complex annuity product and historically the most expensive. The combination of subaccount fees, M&E charges, rider charges, and surrender charges can produce all-in annual costs of 2.5% to 3.5%, which significantly drags long-term returns. The optional living-benefit riders are the main reason consumers buy them — for the guaranteed lifetime income floor — not for the subaccount investing.
How to evaluate
Read the prospectus. Specifically: M&E charge, administrative charge, fund expense ratios for the subaccounts being used, rider charges, and the rider's benefit base calculation. The benefit base is what determines the guaranteed income — its growth rate and step-up provisions matter more than the subaccount selection for most buyers.
In the contract
The prospectus is the primary document — it is much longer than a fixed annuity contract because of SEC disclosure requirements. Key sections: fee table, expense examples, subaccount lineup with expense ratios, rider terms, surrender schedule, and the death-benefit description.
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