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Characteristics, Uses and Taxation of Investments - Sub Accounts



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Sub Accounts
- these are the vehicles which hold the funds that make up the investments in variable annuities and variable life insurance. One may think of sub accounts as mutual funds with an insurance wrapper in the form of a mortality guarantee that enables the annuitant to receive income for life with both the opportunity to generate capital gains as well as the possibility of losing value due to downside volatility, all in a tax deferred environment.

Mutual Funds and Variable Annuities Compared

Mutual Fund Variable Annuity
Sales Charge 8.5% maximum No maximum
Pricing Daily NAV calculation Daily Unit Value calculation
Share Value Function of fund performance Function of Separate Account Performance
Regulated by 1933 Act 1933 Act
1934 Act 1934 Act
Investment Company Act of 1940 Investment Company Act of 1940
Investment Advisors Act of 1940 Investment Advisors Act of 1940
Compensation to manager Portfolio manager receives a fee Separate Account Manager receives a fee
Earnings Accumulation Taxable flow-through of capital gains and dividends to investors, even if reinvested Any distributions increase the value of separate account units
Income Guarantee None Guaranteed Lifetime Income

The Annuitization process: once the client chooses to annuitize, the insurer's actuarial department determines the initial value of the annuity units and the first month's payment amount. Here the assumed interest rate (AIR) is established, a conservative projection of the separate account's performance over the contract's projected life. The annuity unit's value and subsequent monthly income payments to the annuitant vary as a function of the separate account performance compared to the AIR. The month-to-month performance varies according to the following rules.
Separate Account Performance Monthly Income
Greater than AIR Greater than that of previous month
Equal to AIR Same as that of previous month
Less than AIR Less than that of previous month

Month2 Month 3 Month 4 Month 5 Month 6
AIR 4% 4% 4% 4% 4%
Sep. Acct. Return 8% 6% 4% 3% 3%
Monthly Income Increases Increases Unchanged Decreases Decreases
Guaranteed Investment Contracts (GICs)

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