Series 7

Packaged Securities - Variable Annuities

Variable annuity contracts, like investment companies, also belong to the category known as "packaged securities".

What is An Annuity?
An annuity is an obligation to pay - or, from your client's point of view, be paid - annually and in perpetuity, as opposed to in a lump sum. Therefore, a fixed annuity is a cash stream that is the same every year, and a variable annuity is one that is subject to change.

What is a Variable Annuity?
More precisely, a variable annuity is a contract between an investor and an insurance company, under which the insurer agrees to make periodic payments to the investor, beginning either immediately or at some future date. The investor purchases a variable annuity contract by making either a single purchase payment or a series of purchase payments.

Variable Annuities vs. Mutual Funds
Variable annuities are typically invested in mutual funds, but they differ from mutual funds in three important ways:
  1. Variable annuities let your client receive periodic payments for the rest of his or her life. This feature offers protection against the possibility of outliving one's assets.

  2. They have a death benefit. If your client dies before the insurer has started making payments, his or her beneficiary is guaranteed to receive a specified amount - typically at least the amount of your client's purchase payments.

  3. Variable annuities are tax-deferred. Your client pays no taxes on the income and investment gains until he or she starts withdrawing money. When your client does withdraw money, though, he or she will be taxed on the earnings at ordinary income tax rates rather than the lower capital gains rate. Still, if your client holds onto the investment until retirement, his or her income tax rate might actually approximate the capital gains rate.
Tax Treatment of Variable Annuities
For most of your clients, your recommendations should reflect the fact that it is better to make the maximum allowable contributions to IRAs and 401(k) plans - which provide similar tax benefits to variable annuities - before investing in a variable annuity.
  • Do not recommend variable annuities for meeting short-term goals; the penalties for early withdrawal outweigh any benefits gained from investing in variable annuities for any purpose other than retirement or estate planning.

  • There is a 10% federal tax penalty for withdrawing money from variable annuities before the age of 59½.
Death Benefit
A common feature of variable annuities is the death benefit. When your client dies, his or her beneficiary will receive the greater of these two options:
  • all the money in the account, or

  • some guaranteed minimum, such as all purchase payments minus prior withdrawals.




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