Variable Annuities

By Kelly Robinson, Spring 2016 Student Intern

In this series, we’re examining annuities and this week we will explore the realm of variable annuities. If you need a refresher on the basics of how annuities work, check out our earlier blogs posts.

Variable annuities are different from the other annuities we discuss for a number of reasons. First, variable annuities are classified as securities, the sale of which is regulated by the SEC and FINRA. Compare this to fixed annuities, which are insurance products and regulated by state insurance commissioners, and indexed annuities, which may or may not be securities, but are typically not regulated by the SEC or FINRA.

Second, variable annuities have a range of various investment options one can choose between such as money market funds, stocks, and bonds. These are each housed within “sub” or “separate” accounts that are offered within the annuity. The rate of return then depends on the performance of those investments chosen, which is where the word “variable” in the name comes from. This can scare some investors away, because there is a risk that you could actually lose your money. Like with a fixed annuity, you can choose to have your payout last for a definite period, or indefinitely, but you may also have the option to choose payouts in a fixed amount or vary by the performance of your investment options.

Third, variable annuities have some built in options or benefits that other do not. The most popular of which is a death benefit rider that allows the investor to pick a beneficiary (typically a spouse or child) that will receive the money when you die. The beneficiary will receive the greater of either all the money in your account or some guaranteed minimum (such as all purchase payments minus prior withdrawals). There is also the option to “step-up” benefits by adding certain items such as locking in your investment performance to hedge against future decline, but these can add substantial fees onto those mentioned below.

Fourth, variable annuities typically have high annual fees and expenses. These range from administrative fees, to investment management fees, to surrender charges. Riders also come with additional fees. Because variable annuities have death benefits, insurance companies will compensate for the risk by charging a Mortality and Expense risk charge, typically at about 1.25% of your account value. It is also important to note that brokers tend to collect a hefty commission for the sale of these annuities (sometimes into the double digits) and may receive additional special compensation for sale of a particular annuity.

Variable annuities are complex products and should be seriously considered before investing. They are likely not the right investment for the majority of those out there. Additionally, other fees and expenses can reduce your bottom line. They are designed for the long-term investor, who is preparing for retirement or some other long-term goal. For a more in-depth look at variable annuities check out the SEC’s Investor Publication on Variable Annuities. Additionally, FINRA is another great source for researching your broker and providing Investor Alerts, which informs investors of fraud that may accompany variable annuities and other securities.