Annuities and Variable Annuities
Annuities and Variable Annuities
This domain tests annuity mechanics from accumulation through payout, with emphasis on variable contracts, separate accounts, units, and the roles of owner, annuitant, and beneficiary. Expect questions on contract types, fees, surrender charges, and suitability.
Core rules
- An annuity is a contract against longevity risk. Deferred annuities accumulate; immediate annuities begin payout soon after purchase. Fixed annuities credit a guaranteed rate; variable annuities invest in subaccounts and fluctuate.
- During accumulation, variable annuity values are measured in accumulation units. At annuitization, accumulation units convert to annuity units; the number of annuity units is generally fixed, but each unit’s value varies with subaccount performance.
- The owner controls the contract, the annuitant’s life measures payout, and the beneficiary receives death benefits. These roles can be the same person but need not be.
- Variable annuities are securities: sold by prospectus, through a broker-dealer, by a FINRA-registered representative who also holds an insurance license. State insurance law also applies.
- Surrender charges, mortality and expense fees, administrative fees, and rider fees reduce returns. Free withdrawal amounts and death benefits vary by contract.
Worked example
An investor buys a deferred variable annuity with a $100,000 purchase payment and a 7% surrender charge schedule. After one year, the subaccounts have grown to $110,000. If the investor surrenders, the surrender charge may apply to a stated amount under the contract, and the taxable gain is calculated with annuity tax rules. If the investor instead annuitizes, the contract converts to annuity units and payments vary with performance. The representative must compare the cost and liquidity of the annuity with alternatives.
Traps
Do not call a variable annuity guaranteed or FDIC-insured. Do not say annuity units are fixed in dollar value. Do not ignore surrender charges or the distinction between accumulation units and annuity units.