Variable Contracts - Features of Variable Annuities

Variable annuities have several important features:

Tax-Deferred Returns
Payments and returns in the annuity grow tax-deferred. That is, all dividends, interest and capital gains are automatically reinvested without incurring local, state or federal taxes. All earnings are taxed at ordinary income tax rates when withdrawn. Returns compound more quickly without the erosive effects of taxes, and the value of the annuity is allowed to grow at a faster pace.

Separate Account and Sub-Accounts
One of the primary features of a variable annuity is the separate account. By law, this account must be kept separate from the insurance company's general account, so that all dividends, interest, gains and losses are separate and apart from the finances of the insurance company.

  • A separate account is considered a security because it holds securities in a pooled form (similar to mutual funds), unlike the general account of a fixed annuity.
  • Separate accounts are regulated by the same laws set forth in the Securities Act of 1933 and are sold by means of a prospectus.
  • It must also be registered under the Investment Company Act of 1940, since the sub-accounts are similar to mutual funds.

Sub-accounts allow the owner to tailor an asset allocation model for specific investment objectives. The number of sub-account choices and the specific funds will depend on the individual variable annuity contract that the investor chooses.

Exam Tips and Tricks
The exam may test you on the separate account in a variable annuity. Make sure you understand why the separate account is considered a security and must be sold with a prospectus!

Death Benefit
A common feature of variable annuities is the death benefit. If the annuitant dies, the person selected as a beneficiary will receive the greater of (a) all the money in the annuity, or (b) some guaranteed minimum, such as all purchase payments minus prior withdrawals.

  • Stepped-Up Death Benefit:

    • Some variable annuities allow investors to choose a "stepped-up" death benefit. Under this feature, the guaranteed minimum death benefit is typically the greater of the actual account value at time of death (or at an earlier policy anniversary) or the total of all purchase payments minus any withdrawals.

    • For example, the guaranteed minimum might be the account value as of a specified date, which may be greater than purchase payments minus withdrawals if the underlying investment options have performed well.

    • The purpose of a stepped-up death benefit is to "lock in" investment performance and to prevent a later decline in the value of the separate account from eroding the amount the annuitant expects to leave to his or her heirs. This feature carries a charge, however, which will reduce the total return each year.
Types and Valuation of Variable Annuities
Related Articles
  1. Chart Advisor

    4 European Stocks to Consider Buying

    European companies, listed on US exchanges, that are providing buying opportunities right now.
  2. Savings

    Become Your Own Financial Advisor

    If you have some financial know-how, you don’t have to hire someone to advise you on investments. This tutorial will help you set goals – and get started.
  3. Retirement

    Why Some Celebs Say 'No Inheritance for My Kids'

    To some of the super rich, inherited wealth is not the ultimate gift, it's a burden. Here's how their children—as well as charities—stand to benefit.
  4. Professionals

    Social Security COLA in 2016? Not Likely

    A cost of living increase for Social Security doesn't look likely in 2016. Here's what retirees should know and what they can do about it.
  5. Professionals

    This Group is the Most Underprepared to Retire

    More than any other demographic, this group is woefully underprepared for retirement. Here's what they can do to change that.
  6. Professionals

    Advisors: Why Older Clients Need Housing Help

    When was the last time you talked to your clients about housing in retirement?
  7. Professionals

    Why Advisors Must Create a Mobile Strategy NOW

    Mobile devices will replace laptops and desktops. Financial advisors must deal with this revolution to ensure their marketing strategies are up to speed.
  8. Professionals

    Why Near-Retirees Shouldn't Sweat the Volatility

    With the stock market bumpy, some folks nearing retirement might be nervous. Here's how to create some wiggle room for your portfolio.
  9. Brokers

    How to Find Wealthier Financial Advisory Clients

    Most financial advisors are eager to add more and wealthier clients to their practice. Here's what it takes.
  10. Forex Fundamentals

    Buying Yuans as a Long-Term Investment: Risks and Rewards

    Examine the current state of the Chinese currency, the renminbi/yuan, and learn whether it is considered a good long-term investment.
  1. Unicorn

    In the world of business, a unicorn is a company, usually a start-up ...
  2. Private Equity Real Estate

    A Definition of "Private Equity Real Estate" and how it applies ...
  3. Put-Call Parity

    A principle that defines the relationship between the price of ...
  4. Encumbrance

    A claim against a property by a party that is not the owner. ...
  5. EBITA

    Earnings before interest, taxes and amortization. To calculate ...
  6. Qualitative Analysis

    Securities analysis that uses subjective judgment based on nonquantifiable ...
  1. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  2. Does working capital include inventory?

    A company's working capital includes inventory, and increases in inventory make working capital increase. Working capital ... Read Full Answer >>
  3. Does working capital include salaries?

    A company accrues unpaid salaries on its balance sheet as part of accounts payable, which is a current liability account, ... Read Full Answer >>
  4. What licenses does a hedge fund manager need to have?

    A hedge fund manager does not necessarily need any specific license to operate a fund, but depending on the type of investments ... Read Full Answer >>
  5. What do hedge fund analysts do?

    A hedge fund analyst primarily provides support to a portfolio manager on how to best structure the hedge fund's investment ... Read Full Answer >>
  6. Can I borrow from my annuity to put a down payment on a house?

    You can borrow from your annuity to put a down payment on a house, but be prepared to pay an assortment of fees and penalties. ... Read Full Answer >>
Hot Definitions
  1. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  2. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  3. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  4. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  5. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  6. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!