A variable annuity is an investment product with insurance features. It allows you to select from a menu of investment choices, typically mutual funds, within the variable annuity and, at a later date—such as retirement—allows you to receive a stream of payments over time. The value of your variable annuity will depend on how your investment choices perform.
Earnings are tax-deferred, but there are penalties for early withdrawal. You pay no taxes on any income and investment gains on the investments that you hold in the variable annuity until you withdraw your money. But when you take your money out, you will be taxed on the earnings at ordinary income tax rates rather than at lower capital gains tax rates associated with other investments, like mutual funds. In addition, you may face a 10% federal income tax penalty if you withdraw the money before you are 59½ years old. Finally, if you’re putting a variable annuity into a tax-advantaged account, like an IRA or other retirement account (e.g., a 401(k) plan), you’ll get no extra tax advantage.
You pay charges when you invest in a variable annuity. Be sure you understand all the charges before you invest. These charges will reduce the value of your account and the return on your investment. Often, they will include:
- Surrender charges. Withdrawals made within a certain period after your purchase payment (usually within six to eight years, but sometimes 10 years or longer) will usually have a “surrender” charge deducted from the amount you withdraw.
- Mortality and expense risk charge. This charge is based on the value of your account—usually around 1.25% of the value of your account per year. It pays for the death benefit, and is sometimes used to pay the insurance company’s costs to sell the contract—like commissions.
- Investment option expenses. Expenses for the investment choices you select.
- Charges for other features. Special features, such as a living benefit, an enhancement to the basic death benefit, or long-term care insurance, often cost extra.
Variable annuities are designed to be long-term investments, to meet retirement and other long-range goals. Variable annuities are not suitable for meeting short-term goals because substantial taxes and insurance company charges may apply if you withdraw your money early. Variable annuities also involve investment risks, just as mutual funds do.
Publication: Variable Annuities – What You Should Know
Investor Bulletin: Variable Annuities – An Introduction
Investor Bulletin: Variable Annuities – Should You Accept A Buyout Offer?
Updated Investor Bulletin: How Fees and Expenses Affect Your Investment Portfolio