CFP
Characteristics, Uses and Taxation of Investments - Sub Accounts
j. 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 |
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