Variable Annuities Overview
Variable annuities are insurance products that also qualify as securities, requiring both an insurance license and a securities license (Series 6) to sell. They combine tax-deferred growth with the potential for higher returns through market exposure.
What Is a Variable Annuity?
A variable annuity is a contract between an investor and an insurance company where:
- The investor makes a lump-sum payment or series of payments
- The money is invested in subaccounts (similar to mutual funds)
- The contract value varies based on investment performance
- At retirement, the investor can receive payments (annuitize) or take withdrawals
Key Point: Unlike fixed annuities where the insurance company guarantees a return, variable annuities shift investment risk to the contract owner.
Contract Parties
| Party | Role |
|---|---|
| Contract Owner | Purchases the annuity, controls the contract, names beneficiary |
| Annuitant | Person whose life determines payout duration (often same as owner) |
| Beneficiary | Receives death benefit if annuitant dies during accumulation phase |
| Insurance Company | Issues contract, provides guarantees, manages separate account |
Separate Account vs. General Account
Variable annuities use a separate account structure:
| Feature | Separate Account (Variable) | General Account (Fixed) |
|---|---|---|
| Investments | Subaccounts chosen by owner | Insurance company portfolio |
| Risk Bearer | Contract owner | Insurance company |
| Returns | Variable based on market | Fixed/guaranteed |
| SEC Regulation | Yes - registered as securities | No - insurance only |
| Protection | Segregated from company creditors | Subject to company claims |
Exam Tip: Separate account assets are legally segregated from the insurance company's general assets, protecting investors if the company becomes insolvent.
Subaccounts
Subaccounts within the separate account function like mutual funds:
- Money market, bond, stock, international options typically available
- Owner selects allocation among subaccounts
- Can reallocate (transfer) among subaccounts
- Each subaccount has its own investment objective and risk profile
Dual Registration Requirement
Because variable annuities are both insurance and securities products, representatives must have:
- Securities License - Series 6 (or Series 7) through FINRA
- Insurance License - State-specific variable products license
- Firm Registration - Both as broker-dealer and with state insurance department
Why Dual Regulation? Variable annuities involve investment risk (securities regulation) AND insurance guarantees like death benefits (insurance regulation).
Variable vs. Fixed Annuities
| Feature | Variable Annuity | Fixed Annuity |
|---|---|---|
| Returns | Based on separate account performance | Guaranteed minimum rate |
| Investment Risk | Owner bears risk | Insurance company bears risk |
| Inflation Protection | Potential for growth | May lose purchasing power |
| Regulation | SEC + State Insurance | State Insurance only |
| License Required | Insurance + Securities | Insurance only |
| Expense Ratios | Higher (M&E, subaccount fees) | Lower |
Key Advantages of Variable Annuities
- Tax-Deferred Growth - No current taxes on earnings until withdrawal
- No Contribution Limits - Unlike IRAs or 401(k)s (for non-qualified)
- Death Benefit - Protects principal for beneficiaries
- Investment Choices - Multiple subaccount options
- Lifetime Income Option - Can annuitize for guaranteed payments
Key Disadvantages of Variable Annuities
- Higher Fees - M&E charges, admin fees, subaccount expenses, rider costs
- Surrender Charges - Penalties for early withdrawal (typically 5-7 years)
- Tax Treatment - Gains taxed as ordinary income (not capital gains)
- Complexity - Many features and options to understand
- Loss of Step-Up - Heirs don't get cost basis step-up at death
What type of account holds the investments in a variable annuity?
Why must a representative hold both a securities license and an insurance license to sell variable annuities?
In a variable annuity, who bears the investment risk?
3.2 Accumulation and Annuity Phases
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