how a variable annuity works

Discover how a variable annuity works, its benefits and risks, and if market-driven returns make sense for your long-term retirement plan. (Variable Annuities: Market-Linked Growth )

Why Variable Annuities Are Worth a Look (and a Second Thought)

If you’re planning for retirement and want more growth potential than a CD or fixed annuity offers, you might be curious about variable annuities. They offer a unique blend of insurance protection and investment opportunity—but they’re not for everyone.

Variable annuities are tied to the performance of investment sub-accounts (think mutual fund-style portfolios), which means more upside—and more risk. If you’re willing to accept market swings in exchange for the possibility of stronger gains, keep reading.

What Is a Variable Annuity?

A variable annuity is a contract between you and an insurance company. You invest a lump sum or make payments over time, and in return, the insurer offers a series of benefits including:

• Tax-deferred growth
• Market-driven returns
• Optional lifetime income guarantees

The value of your account fluctuates based on the performance of the underlying sub-accounts, which resemble mutual funds.

How Do Variable Annuities Work?

Investment Phase

You choose from a selection of sub-accounts, which may include:

• U.S. equity funds
• International stock funds
• Bond funds
• Balanced portfolios

Your account value rises or falls with market performance.

Income Phase

At retirement, you can:

• Take lump-sum withdrawals
• Convert to annuity payments for life (aka “annuitization”)
• Combine options, depending on your contract

Benefits of Variable Annuities

While not as predictable as fixed annuities, variable annuities offer compelling advantages:

• Potential for Higher Growth — Unlike fixed interest products, you can benefit from strong market years.
• Tax-Deferred Growth — Like a traditional IRA or 401(k), you don’t pay taxes until you withdraw.
• Death Benefits — Your heirs may receive your original investment, even if your account lost value.
• Optional Income Riders — Add-ons can provide guaranteed lifetime income regardless of market performance.

Risks to Consider

With reward comes risk. Here are the main caveats:

• Market Risk — Your account can lose value, sometimes significantly.
• High Fees — Mortality & expense (M&E) charges, fund fees, and rider costs can add up.
• Surrender Periods — Early withdrawals may trigger steep penalties.
• Tax Penalties — Withdrawals before age 59½ may be subject to a 10% IRS penalty.

Explore how variable annuities compare to other retirement options.

Who Should Consider a Variable Annuity?

Variable annuities are ideal for:

• Investors comfortable with market volatility
• Individuals who have maxed out 401(k) or IRA contributions
• Those wanting guaranteed income options later in life
• People seeking a tax-deferred growth vehicle with death benefits

They may not be ideal if you’re risk-averse or focused on low-cost investments.