Variable Annuity Explained
By Hans Goldstein, EA, founder, Retirement Literacy Foundation · Updated
Admitted to practice before the IRS.
How it works
- You choose sub-accounts (stock, bond, money market). Your value moves with them, so you can lose money.
- Gains are not taxed while they stay inside, and you can move between sub-accounts without tax.
- Most contracts include a basic death benefit, often the greater of the account value or premiums paid, less withdrawals.
The layers of fees
- Mortality and expense (M&E) charge and administrative fees on the whole account each year.
- Sub-account expenses, like mutual fund expense ratios.
- Rider charges for guaranteed income or enhanced death benefits.
- Surrender charges in the early years. See surrender charges.
Read the fee table in the prospectus and add the layers together; the total is often much higher than a typical index fund.
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Taxes
Gains come out as ordinary income, even if they came from stocks that would otherwise get capital gains rates, and heirs get no step-up in basis. That is the main tax trade-off compared with investing in a regular taxable account. See how annuities are taxed and the non-qualified annuity tax trap.
Who regulates it
Variable annuities are registered with the SEC and sold by FINRA-registered representatives. You get a prospectus, and FINRA's suitability and Regulation Best Interest rules apply.
Common questions
Can you lose money in a variable annuity?
Yes. The value follows the sub-accounts and can fall with the market. Riders can guarantee certain benefits for an extra charge.
How are variable annuity gains taxed?
As ordinary income when withdrawn, not at capital gains rates. Heirs owe ordinary income tax on the gain too.
What is the difference between a variable and a fixed index annuity?
A variable annuity invests directly in market sub-accounts and can lose value. A fixed index annuity credits interest linked to an index with a 0% floor and caps on the upside.
Sources (checked October 10, 2026): SEC Investor.gov, variable annuities; IRS Publication 575, 2025 (tax rules).
Related
- Fixed index annuity explained
- The non-qualified annuity tax trap
- Annuity types, pros and cons
- Annuity commissions
- All annuity education pages
More on annuities: How Do Annuities Work? A Plain-English Guide · How Are Annuities Taxed? · Inherited Annuity Taxes · 1035 Exchange · Annuities in an IRA · Annuity Surrender Charges and How to Get Out of an Annuity · Types of Annuities and Their Pros and Cons · What Is a MYGA? Multi-Year Guaranteed Annuities Explained · Fixed Index Annuity Explained · Immediate Annuity (SPIA) Explained · Annuity vs CD
Education only; nothing is sold here and no product is recommended. The Foundation's work is independent of any outside professional activity. RLF sells nothing and accepts no funding from financial companies. Tax rules depend on your situation; check with a tax professional before acting.
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Hans Goldstein, EA
Founder & Executive Director · Retirement Literacy Foundation, a 501(c)(3) non-profit
Admitted to practice before the IRS
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