Making the Most Informed Decision when Comparing Variable Annuities - Everything You Need to Know

Introduction

Variable annuities are long-term investment contracts that combine investment growth potential with insurance features, designed to provide income during retirement. Understanding and comparing variable annuities is critical for investors because fees, investment options, and payout structures can vary widely, impacting your returns and risk exposure. To make an informed decision, you need to focus on key factors like expense ratios, contract terms, riders (additional benefits), surrender charges, and the financial strength of the insurer. Grasping these elements helps you choose a variable annuity that aligns with your retirement goals and risk tolerance.

What are the main types of variable annuities available?

Differences between fixed and variable annuities

Fixed and variable annuities serve different investment goals with important distinctions. Fixed annuities guarantee a set interest rate and predictable income, making them safer but less flexible. Variable annuities, by contrast, link your returns to the performance of underlying investment options like mutual funds, so your income can grow more but also fluctuate with market swings.

Fixed annuities suit conservative savers needing stability, while variable annuities appeal if you're comfortable with market risk and want to harness growth potential. Understanding risk tolerance and investment timeline helps you decide. For instance, a 60-year-old aiming to lock in steady income might favor fixed, while a 50-year-old seeking higher retirement income growth might lean toward variable.

Both annuity types offer death benefits and tax deferral, but remember: variable annuities carry market risk, and fees tend to be higher due to investment management and optional features.

Role of optional riders and how they affect choices

Optional riders are add-ons that customize your variable annuity, adding guarantees or income benefits. Common riders include guaranteed lifetime withdrawal benefits (GLWB), enhanced death benefits, and long-term care coverage. These help manage risk but come at a cost.

For example, a GLWB rider might guarantee an income stream for life regardless of market losses, which suits retirees worried about outliving savings. But riders can add 0.5% to 1.5% annually to your fee load, so weigh if the promise justifies that cost. Some riders can also restrict flexibility, like limiting lump-sum withdrawals.

Ask yourself: Does the rider align with your retirement goals? For instance, if you want steady income with downside protection, a GLWB rider makes sense. But if you prefer maximum growth and flexibility, skipping riders might be smarter.

Impact of investment options within variable annuities

Variable annuities function like mutual funds inside the contract, with a menu of sub-accounts where your premiums are invested. These range from stock-focused funds to bonds and balanced portfolios. The variety and quality of these options impact your potential returns and risk level.

A good annuity offers a broad and well-managed lineup, including low-cost index funds and actively managed choices. Poor investment options or high internal fund fees can drag on your growth.

Review each sub-account's historical performance, volatility, and fees. For example, if your annuity's investment options lean heavily on high-fee active funds with weak return records, you'll likely earn less. Also, consider how the funds fit your risk profile: aggressive equities for longer horizons, balanced funds for moderate risk, and bonds for conservative approaches.

How do fees and charges vary among variable annuities?

Breakdown of common fees: mortality, administrative, and investment management

Variable annuities come with several layers of fees that can affect your returns significantly. The mortality and expense (M&E) fee covers the insurer's risk of paying lifetime income and death benefits. This fee typically ranges between 1.0% and 1.5% annually of your account value. Next is the administrative fee, usually around 0.1% to 0.3%, which covers record keeping and customer service costs. The third major fee is the investment management fee, applied to the separate funds your money is invested in, often between 0.5% and 1.0%. It's important to add these up because a combined fee of 2% or higher annually is not unusual and can erode growth over time.

Here's what you should do: always get a clear itemization of these costs. Ask providers to show you the impact of fees on hypothetical account performance-it'll help you see the real cost beyond simple percentages.

How surrender charges work and their financial impact

Surrender charges are penalties for withdrawing more than allowed or canceling the annuity contract early. They typically kick in during the first 5 to 10 years following purchase. These charges often start high, around 7% to 8% in year one, then decline yearly to zero. For example, if you withdraw $50,000 in year two and face a 6% surrender charge, that's a $3,000 hit right off the bat.

These fees are designed to discourage early withdrawal but can seriously limit your liquidity. If you expect to need access to your funds, look for contracts with shorter surrender periods or lower fees. Also, check for any available penalty-free withdrawal options (like a 10% annual free withdrawal allowance).

Comparing fee structures between providers

Fee structures vary widely depending on the insurer and product. Some providers bundle fees, while others break them out separately. Always ask for a full fee disclosure document. It's also good to check if fees reduce as your account balance rises or if there are fee waivers for specific conditions.

Lastly, watch for fees tied to optional riders (guarantees or income riders)-these can add 0.25% to 0.75% annually and are sometimes negotiable. The best approach is a side-by-side fee comparison of similar products to understand where you get the best value for your money.

What should you know about the investment options in variable annuities?

Range and diversity of sub-accounts offered

Variable annuities bundle investment choices into sub-accounts-think of these as smaller investment funds within your annuity. Providers often offer a broad selection, sometimes over 100 sub-accounts, covering stocks, bonds, and alternative assets. This range gives you flexibility to tailor your portfolio based on your goals and risk tolerance.

Look beyond the number of options-check the variety. For example, many annuities split equity sub-accounts between U.S. large-cap, small-cap, international, and emerging markets. Fixed income choices might include government bonds, corporate bonds, and high-yield bonds. Some products add real estate or commodities exposure through specialty sub-accounts.

Choose a provider with sub-accounts that align with your investment style and diversification needs. A strong lineup lets you spread your money across asset classes, managing risk while chasing returns.

Risk and return profiles of typical underlying funds

Every sub-account carries its own risk-return profile, which fundamentally shapes your variable annuity's performance. For instance, equity sub-accounts generally target higher returns but with higher volatility. Bond sub-accounts trade off lower returns for more stability.

Here's the quick math: a growth-focused portfolio weighted heavily in stocks could aim for a 7%-9% annual return, but with swings of ±20% or more. On the other hand, a balanced portfolio mixing bonds might see 4%-6% returns with less fluctuation, say ±8%.

Stay mindful of your time horizon. If you're younger, you can tolerate more volatility chasing growth. Near retirement, shifting to conservative sub-accounts helps protect gains. And keep in mind, past fund returns are no guarantee, but understanding risk profiles helps set realistic expectations.

How investment choices affect overall annuity performance

Your choice of sub-accounts drives the variable annuity's value over time. That means picking funds isn't just about chasing the highest returns; it's about balance and fees.

Fees vary across sub-accounts and can eat into returns, sometimes reducing growth by 1-2 percentage points annually. Compare expense ratios and the insurer's investment management fees-this directly impacts your net gains.

Also, switching sub-accounts often triggers transaction fees or limits, so plan your investment strategy thoughtfully. Align your selections with goals like income needs, growth, or capital preservation. Over 10 years, a 1% fee difference could cut thousands from your final balance on a $100,000 investment.

How riders and guarantees influence the value of variable annuities

Types of guarantees: income, death benefit, and long-term care riders

Variable annuities come with several riders, which are add-ons designed to provide specific guarantees beyond the base contract. The most common are income riders, death benefit riders, and long-term care riders. An income rider guarantees a minimum stream of income regardless of market performance, making it a safe choice if you want steady cash flow in retirement. A death benefit rider ensures your beneficiaries receive at least the original investment or a preset guaranteed amount, even if the market value dips. Lastly, long-term care riders help cover expenses related to extended medical care, turning part of your annuity into supplemental healthcare funding. Each of these riders targets different financial needs, so choosing the right ones depends heavily on your priorities.

Costs associated with adding riders

Adding riders raises the overall expense of your variable annuity. These costs typically come in the form of extra fees expressed as a percentage of your account value, ranging from about 0.25% to 1.5% annually. For example, a guaranteed lifetime withdrawal benefit rider might cost around 1% of the account value each year. These fees can significantly chip away at your investment returns over time, so it's critical to calculate their impact carefully. Some riders also come with initial setup charges or administrative fees. Always ask providers for a clear, detailed fee breakdown and factor this into your total cost comparison.

Balancing guaranteed income versus growth potential

When evaluating riders, you face a trade-off between security and growth. Riders that provide guaranteed income protect against market downturns but often limit upside potential by charging extra fees or capping returns. Without riders, your annuity's value moves fully with your investment options, which can lead to higher long-term growth-but also higher risk. To strike the right balance, consider your risk tolerance, retirement timeline, and income needs. If you rely on steady income and want downside protection, guaranteed income riders add value despite their cost. If growth is your priority and you have other income sources, minimizing riders might make more sense.

What Role Does the Insurer's Financial Strength Play in Your Decision?

Importance of Insurer Credit Ratings

Your annuity is only as secure as the company behind it. Insurer credit ratings come from agencies like Moody's, Standard & Poor's, and A.M. Best, who assess the company's financial health and ability to meet obligations. A rating of A or higher generally means a strong insurer with reliable payment capacity.

Always check the insurer's current credit rating before you commit. A downgrade signals increased risk, potentially affecting your future payouts. For example, an insurer rated BBB or lower may still pay but with more uncertainty, especially if economic conditions worsen.

Best practice: Select annuities from firms with stable or improving credit outlooks. Don't overlook smaller providers with excellent ratings, but verify recent financial news and updates.

How Financial Strength Affects Annuity Security

Financial strength translates into ability to cover claims-including guaranteed income and death benefits-over the long term. Strong insurers have deep reserves and diversified investments to cushion financial shocks.

In 2025, the strongest insurers maintained reserve levels often exceeding regulatory minimums by 20-30%, giving a buffer against market downturns. This means your contract is better protected during economic volatility.

Without solid financial backing, insurers may impose restrictions, delay payments, or in worst cases, face insolvency, risking partial or full loss of benefits. Look beyond marketing and research the insurer's recent solvency ratios and regulatory filings for a clear view.

Evaluating Insurer Longevity and Claim-Paying Ability

Longevity matters because annuities lock your money up for years, sometimes decades. An insurer around for 80+ years with consistent claim-paying history signals reliability. Avoid companies heavily restructured or acquired in recent years without clear stability plans.

Check the insurer's claim-paying history by reviewing annual reports or third-party financial analyses. How often and how quickly do they pay claims? Slow or denied claims could mean trouble.

Don't just trust size alone; some large insurers have struggled despite scale. Look for transparency, governance quality, and user reviews focused on claim experiences.

How tax implications and liquidity factors shape your annuity selection

Tax deferral benefits and potential penalties

Variable annuities offer a key benefit: your investments grow tax-deferred. That means you don't pay taxes on earnings until you withdraw money. This can accelerate compounding returns over time by letting gains build without annual tax drag.

But watch out for penalties. Withdrawals before age 59½ often trigger a 10% IRS early withdrawal penalty on earnings, on top of regular income tax. This can seriously cut your return if you tap your money too soon. Also, distributions are taxed as ordinary income, which might be higher than capital gains rates.

Here's the quick math: If your annuity earns 7% annually but you lose 10% plus taxes on early withdrawal, your net benefit shrinks fast. So treat tax deferral as a long-term advantage-not a short-term cash source.

Understanding withdrawal limits and penalties for early exit

Variable annuities usually restrict how and when you can take money. Most contracts include surrender charges that can last 5-10 years after purchase. These fees can run from 5% down to zero, declining annually.

Besides surrender charges, there are often limits on how much you can withdraw annually without triggering extra fees-commonly around 10% of your contract value. Taking out more means penalties or losing guarantees tied to your contract.

Keep in mind some contracts also have free withdrawal periods or penalty-free withdrawal amounts, but they vary widely between providers. Check the fine print carefully because early and large withdrawals can seriously reduce your invested principal.

Matching liquidity needs with annuity contract terms

If you expect to need quick access to your money, a variable annuity might not be your best fit. These products are made with long-term investors in mind and typically impose restrictions and fees on early withdrawals.

To gauge suitability, compare the annuity's liquidity terms against your financial timeline. For example, if you want penalty-free withdrawals in 3 years but the contract has a 7-year surrender period, that mismatch could cost you thousands in fees.

Also consider the impact of liquidity restrictions on other parts of your portfolio. You want enough flexibility elsewhere to avoid forced, costly withdrawals from your annuity in emergencies.