Variable Annuity
An insurance contract whose value fluctuates based on the performance of underlying investment subaccounts.
What is Variable Annuity?
A variable annuity is an insurance product that combines investment and insurance features: premiums are invested in subaccounts — similar to mutual funds — and the account value fluctuates with market performance. Variable annuities offer tax-deferred growth, optional riders for guaranteed minimum income or death benefits, and the option to annuitize for lifetime income. In the accumulation phase, earnings grow tax-deferred; in the distribution phase, withdrawals are taxed as ordinary income. Critics point to high fees — including mortality and expense (M&E) charges, administrative fees, and optional rider costs — that often total 2–4% annually and significantly drag long-term performance. Variable annuities are regulated by both state insurance commissioners and the SEC due to their securities component.
Example
An investor puts $100,000 into a variable annuity with subaccounts that mirror S&P 500 index funds. Over 20 years, the market returns 7% annually, but the annuity charges 2.5% in annual fees. Net return is approximately 4.5% per year, growing the account to about $241,000. In a comparable low-cost index fund with 0.1% fees, the same investment would grow to approximately $387,000 — illustrating the long-term cost of high variable annuity fees.