A variable annuity invests your money in subaccounts, which work much like mutual funds, so your account value rises and falls with the markets and you carry all of the investment risk. It grows tax-deferred and can include a death benefit and optional income guarantees, but every protection costs extra.
Variable annuities are the most complex and most fee-heavy of the four annuity types. This lesson explains how they work, what they really cost, and how they compare with the MYGAs, FIAs and RILAs you have already studied.
How does a variable annuity work?
A variable annuity pays no guaranteed interest rate. You choose from a menu of stock, bond and money market subaccounts, and your balance follows their results.
- No built-in floor or buffer. Unlike an FIA or RILA, losses pass straight through to you unless you buy a rider that limits them.
- Registered as a security. Variable annuities come with a prospectus and are regulated by the SEC as well as state insurance departments.
- A free look period. After you buy, you usually have 10 to 30 days to cancel, depending on your state and contract.
- Share classes. The same product can be sold in several versions with different fees and surrender schedules. The right one depends on how long you will hold it.
What does a variable annuity cost?
Variable annuity fees stack up in layers, and each layer is charged separately. The SEC’s investor bulletin on variable annuities lists the main ones.
| Fee | What it pays for | Typical size |
|---|---|---|
| Mortality and expense charge | The insurer’s guarantees, costs and profit | Often about 1.25% a year |
| Administrative fee | Record keeping and servicing | About 0.15% a year, or a flat $25 to $50 |
| Subaccount expenses | Running the underlying funds | Varies by fund |
| Rider fees | Optional income or death benefit guarantees | Extra, often charged on a benefit base |
With riders added, total annual costs can run well above 2%. On a hypothetical $200,000 account, 2.5% a year is $5,000, charged whether the markets rise or fall. Our breakdown of annuity fees shows how to add them up from a prospectus.
Surrender charges come on top of these fees. The SEC notes that surrender periods typically last six to eight years, sometimes ten, with a first-year charge around 7% that steps down each year.
Who might a variable annuity make sense for?
- High earners with maxed-out retirement plans. Tax deferral on a large taxable balance can matter when 401(k) and IRA limits are already used up.
- Buyers who want a guaranteed income floor. Some living benefit riders guarantee a minimum income or withdrawal amount even if the subaccounts perform poorly.
- Investors who want market exposure with annuity features. Some buyers value the death benefit and the ability to name beneficiaries directly.
The flip side matters just as much. Inside an IRA, a variable annuity adds no extra tax deferral, so you would be paying for features you may not need. Without a rider, you can lose principal.
How do the four annuity types compare side by side?
Here are the four types from Module 2 in one place. Use it to match a product to your goal before you look at any specific contract.
| Feature | MYGA | Fixed index annuity | RILA | Variable annuity |
|---|---|---|---|---|
| Principal protection* | Strong | Strong | Partial | Minimal without riders |
| Market upside | None | Partial | Partial to strong | Strong |
| Tax deferral | Yes | Yes | Yes | Yes |
| Layered fees | Minimal | Low | Moderate | High |
| Complexity | Low | Moderate | Moderate | High |
| Surrender period | 3 to 10 years | 5 to 10 years | 5 to 10 years | 5 to 10 years |
| Best for | CD-style savers | Conservative growth | Moderate-risk growth | Tax-shelter buyers |
*Principal protection is a contractual guarantee of the issuing insurer, backed by its claims-paying ability. It is not FDIC insured and not a bank deposit. State guaranty association limits apply if an insurer fails.
A variable annuity can be a good fit for the right buyer and a costly mistake for everyone else. If you are considering one, get a second opinion from someone who is not paid on the sale, such as a fee-only planner or a CPA.
- What is my total annual cost in dollars, counting the M&E charge, admin fee, fund expenses and every rider?
- Which share class is this, and why does it fit how long I plan to hold it?
- How long is the surrender schedule, and what is the charge each year?
- Without a rider, how much could I lose in a bad year?
- What exactly does each rider guarantee, and can its fee go up?
- If this goes in an IRA, what am I paying for beyond tax deferral I already have?
Check your understanding
Try these five questions on variable annuities and the four-type comparison.
Lesson 7 quiz: Variable annuities and the four types
5 questions. No sign-up, nothing saved to our servers.
Common questions
Can you lose money in a variable annuity?
Yes. Your account follows the subaccounts you choose, so market losses reduce your balance unless a rider you paid for limits them.
Do variable annuities have a death benefit?
Many include a basic death benefit that pays your beneficiary at least what you paid in, minus withdrawals, even if the account has fallen. Enhanced versions cost extra, so check the prospectus for the exact terms.
Can you move out of a variable annuity you already own?
Often yes, through a 1035 exchange into another annuity without triggering tax. Check the surrender charge first, and make sure the new contract does not start a long new surrender period without a good reason.
You now know all four annuity types and where each one fits. With the variable annuity covered, Module 3 begins next with long-term care riders, an optional add-on that can pay extra if you need care.