3.1 Variable Annuities Overview
Key Takeaways
Variable annuities are insurance products and securities, requiring dual licensing.
Separate account assets are invested in subaccounts and are segregated from the insurer.
The contract owner bears investment risk in a variable annuity.
Advantages include tax deferral, death benefits, and income options.
Disadvantages include higher fees, surrender charges, and ordinary income taxation.
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?
General account
Separate account
Trust account
Escrow account
Why must a representative hold both a securities license and an insurance license to sell variable annuities?
It is a federal requirement for all annuity products
Variable annuities are both insurance products and securities with investment risk
The insurance license covers the sales charge and the securities license covers the investment
State laws require dual licensing for any retirement product
In a variable annuity, who bears the investment risk?
The insurance company
The state insurance commissioner
The contract owner
FINRA
Sections you finish are checked off in the contents.