What You Should Know
have become a part of the retirement and investment plans of many
Americans. Before you buy a variable annuity, you should know
some of the basics – and be prepared to ask your insurance agent,
broker, financial planner, or other financial professional lots
of questions about whether a variable annuity is right for you.
This is a general
description of variable annuities – what they are, how they work,
and the charges you will pay. Before buying any variable annuity,
however, you should find out about the particular annuity you
are considering. Request a prospectus from the insurance company
or from your financial professional, and read it carefully. The
prospectus contains important information about the annuity contract,
including fees and charges, investment options, death benefits,
and annuity payout options. You should compare the benefits and
costs of the annuity to other variable annuities and to other
types of investments, such as mutual funds.
What Is a Variable
A variable annuity
is a contract between you and an insurance company, under which
the insurer agrees to make periodic payments to you, beginning
either immediately or at some future date. You purchase a variable
annuity contract by making either a single purchase payment or
a series of purchase payments.
A variable annuity
offers a range of investment options. The value of your investment
as a variable annuity owner will vary depending on the performance
of the investment options you choose. The investment options for
a variable annuity are typically mutual funds that invest in stocks,
bonds, money market instruments, or some combination of the three.
annuities are typically invested in mutual funds, variable annuities
differ from mutual funds in several important ways:
annuities let you receive periodic payments for the rest
of your life (or the life of your spouse or any other person you
designate). This feature offers protection against the possibility
that, after you retire, you will outlive your assets.
annuities have a death benefit. If you die before the insurer
has started making payments to you, your beneficiary is guaranteed
to receive a specified amount – typically at least the amount
of your purchase payments. Your beneficiary will get a benefit
from this feature if, at the time of your death, your account
value is less than the guaranteed amount.
annuities are tax-deferred. That means you pay no taxes
on the income and investment gains from your annuity until you
withdraw your money. You may also transfer your money from one
investment option to another within a variable annuity without
paying tax at the time of the transfer. When you take your money
out of a variable annuity, however, you will be taxed on the earnings
at ordinary income tax rates rather than lower capital gains rates.
In general, the benefits of tax deferral will outweigh the costs
of a variable annuity only if you hold it as a long-term investment
to meet retirement and other long-range goals.
Other investment vehicles, such as IRAs and employer-sponsored
401(k) plans, also may provide you with tax-deferred growth
and other tax advantages. For most investors, it will be
advantageous to make the maximum allowable contributions
to IRAs and 401(k) plans before investing in a variable
In addition, if you are investing in a variable annuity
through a tax-advantaged retirement plan (such as a 401(k)
plan or IRA), you will get no additional tax advantage
from the variable annuity. Under these circumstances, consider
buying a variable annuity only if it makes sense because
of the annuity's other features, such as lifetime income
payments and death benefit protection. The tax rules that
apply to variable annuities can be complicated – before
investing, you may want to consult a tax adviser about the
tax consequences to you of investing in a variable annuity.
Variable annuities are designed to be long-term investments,
to meet retirement and other long-range goals. Variable annuities
are not suitable for meeting short-term goals because substantial
taxes and insurance company charges may apply if you withdraw
your money early. Variable annuities also involve investment
risks, just as mutual funds do.
How Variable Annuities
A variable annuity
has two phases: an accumulation phase and a payout phase.
During the accumulation
phase, you make purchase payments, which you can allocate
to a number of investment options. For example, you could designate
40% of your purchase payments to a bond fund, 40% to a U.S. stock
fund, and 20% to an international stock fund. The money you have
allocated to each mutual fund investment option will increase
or decrease over time, depending on the fund's performance. In
addition, variable annuities often allow you to allocate part
of your purchase payments to a fixed account. A fixed account,
unlike a mutual fund, pays a fixed rate of interest. The insurance
company may reset this interest rate periodically, but it will
usually provide a guaranteed minimum (e.g., 3% per year).
You purchase a variable annuity with an initial purchase
payment of $10,000. You allocate 50% of that purchase payment
($5,000) to a bond fund, and 50% ($5,000) to a stock fund. Over
the following year, the stock fund has a 10% return, and the
bond fund has a 5% return. At the end of the year, your account
has a value of $10,750 ($5,500 in the stock fund and $5,250
in the bond fund), minus fees and charges (discussed below).
Your most important
source of information about a variable annuity's investment options
is the prospectus. Request the prospectuses for the mutual fund
investment options. Read them carefully before you allocate your
purchase payments among the investment options offered. You should
consider a variety of factors with respect to each fund option,
including the fund's investment objectives and policies, management
fees and other expenses that the fund charges, the risks and volatility
of the fund, and whether the fund contributes to the diversification
of your overall investment portfolio. The SEC's online publication,
Mutual Fund Investing:
Look at More Than a Fund's Past Performance, provides
information about these factors. Another SEC online publication,
Invest Wisely: An Introduction
to Mutual Funds, provides general information about the
types of mutual funds and the expenses they charge.
During the accumulation
phase, you can typically transfer your money from one investment
option to another without paying tax on your investment income
and gains, although you may be charged by the insurance company
for transfers. However, if you withdraw money from your account
during the early years of the accumulation phase, you may have
to pay "surrender charges," which are discussed below. In addition,
you may have to pay a 10% federal tax penalty if you withdraw
money before the age of 59½.
At the beginning
of the payout phase, you may receive your purchase payments
plus investment income and gains (if any) as a lump-sum payment,
or you may choose to receive them as a stream of payments at regular
intervals (generally monthly).
If you choose to
receive a stream of payments, you may have a number of choices
of how long the payments will last. Under most annuity contracts,
you can choose to have your annuity payments last for a period
that you set (such as 20 years) or for an indefinite period (such
as your lifetime or the lifetime of you and your spouse or other
beneficiary). During the payout phase, your annuity contract may
permit you to choose between receiving payments that are fixed
in amount or payments that vary based on the performance of mutual
fund investment options.
The amount of each
periodic payment will depend, in part, on the time period that
you select for receiving payments. Be aware that some annuities
do not allow you to withdraw money from your account once you
have started receiving regular annuity payments.
In addition, some
annuity contracts are structured as immediate annuities,
which means that there is no accumulation phase and you will start
receiving annuity payments right after you purchase the annuity.
The Death Benefit
and Other Features
A common feature
of variable annuities is the death benefit. If you die,
a person you select as a beneficiary (such as your spouse or child)
will receive the greater of: (i) all the money in your account,
or (ii) some guaranteed minimum (such as all purchase payments
minus prior withdrawals).
You own a variable annuity that offers a death benefit equal
to the greater of account value or total purchase payments minus
withdrawals. You have made purchase payments totaling $50,000.
In addition, you have withdrawn $5,000 from your account. Because
of these withdrawals and investment losses, your account value
is currently $40,000. If you die, your designated beneficiary
will receive $45,000 (the $50,000 in purchase payments you put
in minus $5,000 in withdrawals).
Some variable annuities
allow you to choose a "stepped-up" death benefit. Under this feature, your
guaranteed minimum death benefit may be based on a greater amount
than purchase payments minus withdrawals. For example, the guaranteed
minimum might be your 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" your investment
performance and prevent a later decline in the value of your account
from eroding the amount that you expect to leave to your heirs.
This feature carries a charge, however, which will reduce your
sometimes offer other optional features, which also have extra
charges. One common feature, the guaranteed minimum income benefit, guarantees a particular
minimum level of annuity payments, even if you do not have enough
money in your account (perhaps because of investment losses) to
support that level of payments. Other features
may include long-term care insurance, which pays for home health
care or nursing home care if you become seriously ill.
You may want to
consider the financial strength of the insurance company that
sponsors any variable annuity you are considering buying. This
can affect the company's ability to pay any benefits that are
greater than the value of your account in mutual fund investment
options, such as a death benefit, guaranteed minimum income benefit,
long-term care benefit, or amounts you have allocated to a fixed
account investment option.
You will pay for each benefit provided by your variable
annuity. Be sure you understand the charges. Carefully consider
whether you need the benefit. If you do, consider whether
you can buy the benefit more cheaply as part of the variable
annuity or separately (e.g., through a long-term
care insurance policy).
You will pay several
charges when you invest in a variable annuity. Be sure you understand
all the charges before you invest. These charges will reduce
the value of your account and the return on your investment.
Often, they will include the following:
charges – If you withdraw money from a variable annuity
within a certain period after a purchase payment (typically
within six to eight years, but sometimes as long as ten years),
the insurance company usually will assess a "surrender" charge,
which is a type of sales charge. This charge is used to pay
your financial professional a commission for selling the variable
annuity to you. Generally, the surrender charge is a percentage
of the amount withdrawn, and declines gradually over a period
of several years, known as the "surrender period."
For example, a 7% charge might apply in the first year after
a purchase payment, 6% in the second year, 5% in the third
year, and so on until the eighth year, when the surrender
charge no longer applies. Often, contracts will allow you
to withdraw part of your account value each year – 10% or
15% of your account value, for example – without paying a
You purchase a variable annuity contract with a $10,000
purchase payment. The contract has a schedule of surrender
charges, beginning with a 7% charge in the first year, and
declining by 1% each year. In addition, you are allowed
to withdraw 10% of your contract value each year free of
surrender charges. In the first year, you decide to withdraw
$5,000, or one-half of your contract value of $10,000 (assuming
that your contract value has not increased or decreased
because of investment performance). In this case, you could
withdraw $1,000 (10% of contract value) free of surrender
charges, but you would pay a surrender charge of 7%, or
$280, on the other $4,000 withdrawn.
and expense risk charge – This charge is equal to a certain
percentage of your account value, typically in the range of
1.25% per year. This charge compensates the insurance company
for insurance risks it assumes under the annuity contract.
Profit from the mortality and expense risk charge is sometimes
used to pay the insurer's costs of selling the variable annuity,
such as a commission paid to your financial professional for
selling the variable annuity to you.
Your variable annuity has a mortality and expense risk charge
at an annual rate of 1.25% of account value. Your average
account value during the year is $20,000, so you will pay
$250 in mortality and expense risk charges that year.
fees – The insurer may deduct charges to cover record-keeping
and other administrative expenses. This may be charged as
a flat account maintenance fee (perhaps $25 or $30 per year)
or as a percentage of your account value (typically in the
range of 0.15% per year).
Your variable annuity charges administrative fees at an
annual rate of 0.15% of account value. Your average account
value during the year is $50,000. You will pay $75 in administrative
Fund Expenses – You will also indirectly pay the fees
and expenses imposed by the mutual funds that are the underlying
investment options for your variable annuity.
Charges for Other Features – Special features offered
by some variable annuities, such as a stepped-up death
benefit, a guaranteed minimum
income benefit, or long-term care
insurance, often carry additional fees and charges.
such as initial sales loads, or fees for transferring part of
your account from one investment option to another, may also apply.
You should ask your financial professional to explain to you all
charges that may apply. You can also find a description of the
charges in the prospectus for any variable annuity that you are
Section 1035 of
the U.S. tax code allows you to exchange an existing variable
annuity contract for a new annuity contract without paying any
tax on the income and investment gains in your current variable
annuity account. These tax-free exchanges, known as 1035 exchanges,
can be useful if another annuity has features that you prefer,
such as a larger death benefit, different annuity payout options,
or a wider selection of investment choices.
You may, however,
be required to pay surrender charges on the old annuity if you
are still in the surrender charge period. In addition, a new surrender
charge period generally begins when you exchange into the new
annuity. This means that, for a significant number of years (as
many as 10 years), you typically will have to pay a surrender
charge (which can be as high as 9% of your purchase payments)
if you withdraw funds from the new annuity. Further, the new annuity
may have higher annual fees and charges than the old annuity,
which will reduce your returns.
If you are thinking about a 1035 exchange, you should compare
both annuities carefully. Unless you plan to hold the new
annuity for a significant amount of time, you may be better
off keeping the old annuity because the new annuity typically
will impose a new surrender charge period. Also, if you
decide to do a 1035 exchange, you should talk to your financial
professional or tax adviser to make sure the exchange will
be tax-free. If you surrender the old annuity for cash and
then buy a new annuity, you will have to pay tax on the
companies are now offering variable annuity contracts with "bonus
credit" features. These contracts promise to add a bonus to your
contract value based on a specified percentage (typically ranging
from 1% to 5%) of purchase payments.
You purchase a variable annuity contract that offers a
bonus credit of 3% on each purchase payment. You make a purchase
payment of $20,000. The insurance company issuing the contract
adds a bonus of $600 to your account.
Variable annuities with bonus credits may carry a downside,
however – higher expenses that can outweigh the benefit
of the bonus credit offered.
will charge you for bonus credits in one or more of the following
surrender charges – Surrender charges may be higher
for a variable annuity that pays you a bonus credit than for
a similar contract with no bonus credit.
surrender periods – Your purchase payments may be
subject to surrender charges for a longer period than they
would be under a similar contract with no bonus credit.
mortality and expense risk charges and other charges
– Higher annual mortality and expense risk charges may be
deducted for a variable annuity that pays you a bonus credit.
Although the difference may seem small, over time it can add
up. In addition, some contracts may impose a separate fee
specifically to pay for the bonus credit.
a variable annuity with a bonus credit, ask yourself – and the
financial professional who is trying to sell you the contract
– whether the bonus is worth more to you than any increased charges
you will pay for the bonus. This may depend on a variety of factors,
including the amount of the bonus credit and the increased charges,
how long you hold your annuity contract, and the return on the
underlying investments. You also need to consider the other features
of the annuity to determine whether it is a good investment for
You make purchase payments of $10,000 in Annuity A and
$10,000 in Annuity B. Annuity A offers a bonus credit of 4%
on your purchase payment, and deducts annual charges totaling
1.75%. Annuity B has no bonus credit and deducts annual charges
totaling 1.25%. Let's assume that both annuities have an annual
rate of return, prior to expenses, of 10%. By the tenth year,
your account value in Annuity A will have grown to $22,978.
But your account value in Annuity B will have grown more, to
$23,136, because Annuity B deducts lower annual charges, even
though it does not offer a bonus.
You should also
note that a bonus may only apply to your initial premium payment,
or to premium payments you make within the first year of the annuity
contract. Further, under some annuity contracts the insurer will
take back all bonus payments made to you within the prior year
or some other specified period if you make a withdrawal, if a
death benefit is paid to your beneficiaries upon your death, or
in other circumstances.
If you already own a variable annuity and are thinking
of exchanging it for a different annuity with a bonus feature,
you should be careful. Even if the surrender period on your
current annuity contract has expired, a new surrender period
generally will begin when you exchange that contract for
a new one. This means that, by exchanging your contract,
you will forfeit your ability to withdraw money from your
account without incurring substantial surrender charges.
And as described above, the schedule of surrender charges
and other fees may be higher on the variable annuity with
the bonus credit than they were on the annuity that you
You currently hold a variable annuity with an account
value of $20,000, which is no longer subject to surrender charges.
You exchange that annuity for a new variable annuity, which
pays a 4% bonus credit and has a surrender charge period of
eight years, with surrender charges beginning at 9% of purchase
payments in the first year. Your account value in this new variable
annuity is now $20,800. During the first year you hold the new
annuity, you decide to withdraw all of your account value because
of an emergency situation. Assuming that your account value
has not increased or decreased because of investment performance,
you will receive $20,800 minus 9% of your $20,000 purchase payment,
or $19,000. This is $1,000 less than you would have received
if you had stayed in the original variable annuity, where you
were no longer subject to surrender charges.
Take a hard look at bonus credits. In some cases, the "bonus"
may not be in your best interest.
Before You Invest
who sell variable annuities have a duty to advise you as to whether
the product they are trying to sell is suitable to your particular
investment needs. Don't be afraid to ask them questions. And write
down their answers, so there won't be any confusion later as to
what was said.
contracts typically have a "free look" period of ten or more days,
during which you can terminate the contract without paying any
surrender charges and get back your purchase payments (which may
be adjusted to reflect charges and the performance of your investment).
You can continue to ask questions in this period to make sure
you understand your variable annuity before the "free look" period
Before you decide
to buy a variable annuity, consider the following questions:
- Will you use
the variable annuity primarily to save for retirement or a similar
- Are you investing
in the variable annuity through a retirement plan or IRA (which
would mean that you are not receiving any additional tax-deferral
benefit from the variable annuity)?
- Are you willing
to take the risk that your account value may decrease if the
underlying mutual fund investment options perform badly?
- Do you understand
the features of the variable annuity?
- Do you understand
all of the fees and expenses that the variable annuity charges?
- Do you intend
to remain in the variable annuity long enough to avoid paying
any surrender charges if you have to withdraw money?
- If a variable
annuity offers a bonus credit, will the bonus outweigh any higher
fees and charges that the product may charge?
- Are there features
of the variable annuity, such as long-term care insurance, that
you could purchase more cheaply separately?
- Have you consulted
with a tax adviser and considered all the tax consequences of
purchasing an annuity, including the effect of annuity payments
on your tax status in retirement?
- If you are exchanging
one annuity for another one, do the benefits of the exchange
outweigh the costs, such as any surrender charges you will have
to pay if you withdraw your money before the end of the surrender
charge period for the new annuity?
Before purchasing a variable annuity, you owe it to yourself
to learn as much as possible about how they work, the benefits
they provide, and the charges you will pay.
For More Information
Other SEC Online
Other Web Sites
That May Be Helpful
— NASD is an independent self-regulatory organization charged
with regulating the securities industry, including sellers of
variable annuities. The NASD has issued several
investor alerts on the topic of variable annuities, and
has also issued a release
to its members giving guidance on how to present information
on the impact of taxes upon investment returns in a variable
annuity as compared to a non-specific taxable account. If you
have a complaint or problem about sales practices involving
variable annuities, you should contact the District Office of
NASD nearest you. A list of NASD District Offices is available
- National Association
of Insurance Commissioners (NAIC) — The NAIC is the national
organization of state insurance commissioners. Variable annuities
are regulated by state insurance commissions, as well as by
the SEC. The NAIC's web site contains an interactive
map of the United States with links to the home pages of
each state insurance commissioner. You may contact your state
insurance commissioner with questions or complaints about variable
How To Contact
the SEC With Questions or Complaints
Office of Investor
Education and Advocacy
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549-0213
Fax: (202) 772-9295
Questions: Fast Answers