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 All earnings are taxed at ordinary income tax rates when withdrawn.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
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