What You Actually Need to Know About Variable Annuities

Variable annuities let you invest the money you put in, unlike fixed annuities

A variable annuity is an insurance contract where the payments you receive later depend on how well the investments inside it perform. You choose from a menu of investment options — usually mutual funds — and your account value rises or falls based on market performance. This is the core difference from a fixed annuity, where the insurance company guarantees a set payment amount regardless of market conditions.

With a variable annuity, you take on the investment risk. If your chosen funds gain value, your annuity grows faster and your future payments are larger. If they lose value, your annuity shrinks and your payments are smaller. The insurance company does not promise you a specific dollar amount at the end — it promises to convert whatever balance you have built into a stream of payments.

Variable annuities are sold by insurance companies and typically require you to be at least 18 years old. They come with surrender charges if you withdraw money early, usually declining over 5 to 10 years. Many also include optional riders — add-ons that cost extra but provide guarantees like a minimum income floor or death benefit protection.

Key Takeaways

• Your variable annuity payment amount is not may provide and depends entirely on how your chosen investments perform over time.
• You select from a list of investment options, usually mutual funds, and bear the risk if those investments lose value.
• Variable annuities charge annual fees for management and insurance, typically ranging from 1 to 3 percent of your account value each year.
• Withdrawing money before the surrender period ends usually triggers a penalty, though some contracts allow a small penalty-free withdrawal each year.
• Optional riders can add guarantees — such as a minimum income amount or a death benefit — but they increase your annual costs.

How investment performance directly affects your payments

When you buy a variable annuity, your money goes into a separate account called a subaccount. You choose which subaccounts to fund — these work like mutual funds and track different markets or strategies. Some track the S&P 500, others track bonds, international stocks, or a mix of asset types.

Every day the markets are open, your subaccount value changes based on the performance of the underlying investments. If you choose a stock-heavy subaccount and the stock market rises 10 percent in a year, your account value rises roughly 10 percent (minus fees). If the market falls 10 percent, your account falls roughly 10 percent. This direct link between market performance and your account value is what makes variable annuities different from fixed annuities.

When you reach the point where you want to start receiving payments — called the annuitization date — the insurance company converts your account balance into a monthly or annual payment. A larger balance means larger payments. A smaller balance means smaller payments. There is no safety net: if the market has been down and your balance is low, your payments reflect that reality.

Fees and costs you will encounter

Variable annuities are expensive relative to other investment vehicles. You will pay multiple layers of fees, and understanding them matters because they compound over decades.

The mortality and expense risk charge (often called the M&E fee) is the insurance company's cut for taking on the risk of your contract. This typically runs 0.5 to 1.5 percent of your account value per year. On top of that, the investment management fee for each subaccount you choose usually ranges from 0.3 to 1 percent annually. If you add optional riders — such as a may provide minimum income rider or a death benefit may provide — those cost an additional 0.5 to 2 percent per year.

You also pay the underlying fund expenses within each subaccount, which can add another 0.5 to 1 percent. Combined, total annual costs often reach 2 to 3 percent or higher. Over a 30-year holding period, these fees significantly reduce the growth of your account.

Surrender charges explore if you withdraw more than a small amount (usually 10 percent per year) during the surrender period. These charges typically start at 5 to 7 percent of the withdrawal amount and decline by 1 percent each year until they reach zero. A 10-year surrender period means you could face a 5 percent penalty if you need your money in year five.

When you can access your money and what it costs

Variable annuities are designed to be long-term contracts. Most include a surrender period lasting 5 to 10 years, during which withdrawals beyond a small annual amount trigger penalties.

Nearly all variable annuities allow you to withdraw a percentage of your account value each year — often 10 percent — without surrender charges. This is meant to give you some access to your money for emergencies. Anything beyond that amount faces a surrender charge that declines over time. Once the surrender period ends, you can withdraw your full balance without penalty, though you may still owe income taxes on any gains.

If you need money before annuitization and face a surrender charge, you have to weigh the penalty against your actual need. A 6 percent surrender charge on a $100,000 account is $6,000 — a real cost that reduces what you have left to spend or reinvest.

Optional riders: guarantees that cost extra

Variable annuities come with optional add-ons called riders that provide specific guarantees. These are not included in the base contract — you pay extra for them, and they increase your annual fees.

A may provide minimum income rider promises that no matter how poorly your investments perform, you will receive a minimum monthly payment when you annuitize. If your account has grown, you get the larger amount based on actual performance. If your account has shrunk, the rider ensures you still get the promised minimum. This rider costs roughly 0.5 to 1.5 percent per year.

A may provide minimum accumulation benefit promises that your account will be worth at least a certain amount on a future date, even if markets fall. This protects your principal but costs extra annually. A death benefit rider ensures that if you die before annuitizing, your beneficiary receives at least your original investment or your current account value, whichever is higher.

These riders sound appealing because they reduce risk, but they are expensive. Before adding one, compare the annual cost against the actual protection it provides in your situation. A rider that costs 1 percent per year for 20 years costs 20 percent of your account value in total fees — a significant amount.

Tax treatment and what happens at annuitization

Variable annuities grow tax-deferred, meaning you do not pay income tax on gains each year the way you would with a regular investment account. This tax deferral is one reason people choose annuities. However, when you finally withdraw money or annuitize, you owe ordinary income tax on all the gains — not the lower capital gains tax rate.

If you buy a variable annuity inside a retirement account like an IRA, the tax deferral provides no additional benefit since IRAs are already tax-deferred. In this case, you are paying annuity fees for a feature you already have, which is generally not a good trade-off.

When you annuitize — convert your account balance into a stream of payments — the insurance company calculates your payment based on your account value, your age, current interest rates, and life expectancy tables. A larger account balance produces larger payments. The payments are typically fixed for life, meaning you receive the same amount each month or year regardless of market performance after annuitization.

Variable annuities versus fixed annuities and other investments

A fixed annuity guarantees a specific payment amount, while a variable annuity's payment depends on investment performance. Fixed annuities are simpler and more predictable but typically offer lower returns. Variable annuities offer growth potential but with higher fees and investment risk.

Compared to investing in a regular brokerage account with mutual funds, variable annuities offer tax deferral but charge much higher fees. A low-cost index fund might cost 0.05 percent per year; a variable annuity subaccount plus M&E fees might cost 1.5 to 2 percent. Over decades, this fee difference compounds into a substantial reduction in your wealth.

Variable annuities make the most sense for people who want may provide income in retirement, can afford the fees, and plan to hold the contract for at least 10 years. They are less suitable for people who need flexibility, want to minimize costs, or plan to access their money within the surrender period.

Frequently Asked Questions

Can I lose money in a variable annuity?

Yes. Your account value rises and falls with the performance of the investments you choose. If the stock market falls significantly and you have invested heavily in stock subaccounts, your account balance will decline. However, if you have added a may provide minimum income rider, your future payment amount is protected even if your account shrinks.

What happens to my variable annuity if I die before annuitizing?

Your beneficiary receives your account balance at the time of death, or the amount you originally invested, whichever is higher — unless you added a death benefit rider with different terms. The contract does not continue; it pays out as a lump sum or in installments depending on what your beneficiary chooses.

Can I move my variable annuity to a different insurance company?

Yes, through a process called a 1035 exchange, which allows you to transfer the contract to another insurance company without triggering when ready taxes. However, you will start a new surrender period with the new company, and fees may differ. Consult a tax professional before doing this.

Is a variable annuity the same as a mutual fund?

No. A mutual fund is just an investment; a variable annuity is an insurance contract that invests in mutual-fund-like subaccounts and promises to convert your balance into lifetime income. Variable annuities charge insurance fees that mutual funds do not, and they offer tax deferral and income guarantees that mutual funds do not.

What if I need my money during the surrender period?

You can withdraw it, but you will pay a surrender charge on any amount over your annual penalty-free withdrawal limit (usually 10 percent). The charge declines each year. If you truly need the money, you pay the penalty; if you can wait, you avoid it by staying within the penalty-free amount or waiting until the surrender period ends.