What are Variable Annuities?

Many investors purchase variable annuities because they are afraid that they will outlive their retirement savings. If you’re considering an annuity, it’s critical to understand what you would be getting into. According to FINRA, “Deferred variable annuities are hybrid investments containing securities and insurance features.” We’re going to look at variable annuities as an investment product, and their benefits and drawbacks.

At first glance, variable annuities sound like a great deal. You put some money in, it grows over time according to the value of the mutual funds inside the variable annuity, and later—when you’re ready to retire—the variable annuity provides a steady income that can even continue paying your beneficiaries when you die. In reality, however, variable annuities are complex financial products that may not be suitable for every investor–particularly elderly ones.

Variable annuities are like mutual funds, but they are a contract between you and an insurance company. Variable annuities are so named because they depend on the performance of the mutual funds you choose. When choosing an annuity, you can get one for your lifetime or a fixed period (say 10 years). If you have enough money, you can even pay for it in one lump sum, or over time; this is the first phase, known as the “accumulation” phase. You can get payouts from the annuity right away (keeping in mind that there is a 10% penalty for withdrawal before age 59 ½) or in the future; this is the payout phase, also known as “annuitization.”

Here are some pros and cons:


  • They provide steady income.
  • They can benefit your heirs even after your death.
  • You pay no taxes until withdrawal.


  • They carry inherent risk and may be volatile depending on the performance of the mutual funds contained within them.
  • High fees cut into your investment. These fees include surrender charges, a base contract fee, administration fees, fees for optional features (like long-term care insurance if you become incapacitated) and on and on…
  • Annuities are not FDIC insured.
  • If the insurance company experiences financial distress, your annuity may be negatively affected.
  • Brokers get a high commission (sometimes as high as 10%).

When you consult with your financial advisor, you would hope that they would have your best interests in mind and recommend a variable annuity only if it is right for you.

According to FINRA Rule 2330:

No member or person associated with a member shall recommend to any customer the purchase or exchange of a deferred variable annuity unless such member or person associated with a member has a reasonable basis to believe … that the transaction is suitable … and, in particular, that there is a reasonable basis to believe that … the customer has been informed, in general terms, of various features of deferred variable annuities, such as the potential surrender period and surrender charge; potential tax penalty if customers sell or redeem deferred variable annuities before reaching the age of fifty-nine-and a half; mortality and expense fees; investment advisory fees; potential charges for and features of riders; the insurance and investment components of deferred variable annuities; and market risk…

Because advisors are subject to FINRA rules, according to ThinkAdvisor, before recommending an annuity to you, a registered representative must consider the following 12 suitability factors:

  1. Your age
  2. Your annual income
  3. Your financial situation and needs, including the financial resources used for the funding of the annuity
  4. Your financial experience
  5. Your financial objectives
  6. Your intended use of the annuity
  7. Your financial time horizon
  8. Your existing assets, including investment and life insurance holdings
  9. Your liquidity needs
  10. Your liquid net worth
  11. Your risk tolerance
  12. Your tax status

In reality, given the high commissions that financial professionals receive from selling variable annuities, your broker or advisor may be pushing you into signing up for one. FINRA maintains that “Due to the complexity and confusion surrounding them, which can lead to questionable sales practices, variable annuities are a leading source of investor complaints to FINRA.”

Therefore it’s important to make sure your advisor is a fiduciary, bound to put their clients’ interests before their own. You should know yourself and your goals. Be sure to ask yourself a few questions as you make your decision. An annuity also comes with a 30-day “free look” period during which you can cancel your annuity without penalty.

Questions to Ask Yourself Before Signing Up for an Annuity

  • What commission will my financial advisor receive if I take out an annuity? Does my financial advisor have my best interests in mind?
  • What can a variable annuity provide me that mutual funds cannot? Am I willing to accept heavy fees to maintain an annuity?
  • What will I do if my variable annuity doesn’t grow or even loses value? Am I willing to accept such risks?
  • Is this the right time to consider an annuity? For example, have I maxed out my IRA and 401(k)?
  • Do I really need a death benefit?
  • Do I understand all fees, including any surrender fees?
  • When will I be able to access my money?

Beware of scams from unscrupulous agents. One common scam is “annuity churning,” in which your agent will convince you to switch your current variable annuity to a different one at the same company. You’ll incur a surrender fee, your agent will walk away with a second commission, and the new variable annuity may be unsuitable for you.

The benefits of variable annuities at first seem numerous, but the drawbacks may give you pause. Consider some alternatives. If mutual funds have lower fees than variable annuities, and annuities contain mutual funds, why not just invest in mutual funds directly? Growth stock mutual funds can be a solid option.

As with any major financial decision, before you sign on the dotted line, make sure you understand what you’re agreeing to. The more informed you are, the more empowered you will be to take control of your finances, avoid fraud, and secure your financial future for years to come. If you have any questions about variable annuities, please feel free to contact our law office at 212-658-1500 or