Retirement Literacy Foundation · Annuity Education

Variable Annuity Explained

By Hans Goldstein, founder, Retirement Literacy Foundation · Updated October 8, 2026

Short answer: A variable annuity invests your money in sub-accounts, which work much like mutual funds, so the value rises and falls with the market. Growth is tax-deferred, and optional riders can guarantee a death benefit or lifetime withdrawals for an extra yearly charge. Variable annuities are securities, sold with a prospectus.

Free annuity guide, 3 pages. How annuities are taxed, what heirs owe, the five main types side by side, and what sellers are paid. Free by email.

Free. Educational follow-up by email. We never sell your information.

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.

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 who must also hold an insurance license. 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As ordinary income when withdrawn, not at capital gains rates.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.

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. Hans Goldstein, founder of the Retirement Literacy Foundation, is also a licensed California insurance producer (#4273294). Tax rules depend on your situation; check with a tax professional before acting.