What is an Annuity? What is a Variable Annuity?

In the financial world, the word annuity may have various and often similar meanings. Below I’ll discuss each and how they may fit in your financial plan.

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An annuity is simply a payment at regular intervals, such as monthly payment from your pension plan. Social Security can also be thought of as an annuity, especially when creating a lifetime retirement income plan. Monthly withdrawals from investment and retirement (IRA, 401k, 403b) accounts are yet another form of an annuity which you establish and control.

The second common meaning for annuity is in reference to the wrapper for the underlying investments. If you own an Individual Retirement Account or 401k Account, those structures refer to the wrapper for the investments contained within. It’s the same concept for the annuity wrapper.

If an annuity is the wrapper, then what’s inside?


A fixed single premium deferred annuity is similar to a Certificate of Deposit (but notably, without FDIC insurance and with different tax rules). You enter into contract with an insurance company and in return you earn a stated rate of return. At the end of the term you’ll receive your money back, as long as you haven’t annuitized the contract. A single premium immediate annuity is a contract that is annuitized at inception. Payments continue for life or for the term of the contract and are irrevocable.


Moving to the deep end, a variable annuity is a contract you execute with an insurance company just like with a fixed annuity. In fact, within the variable annuity you’ll probably find…a fixed annuity. If you don’t end up using any sub-accounts (touched on below), you’ll have a variable fixed annuity!

More than likely, you’ll be using the limited investment sub-accounts so your money can grow which is what makes it a variable annuity. It is possible to lose money in the variable sub-accounts, though the implication is that these products are safe…

…and they may actually be safe, depending on how you define it. Many types of riders exist that can be and often are added (sold) to the variable annuity contracts which purport to give you the best of all worlds: investment growth, lifetime income, and principle account value guarantees.

Let me mention that there are no free rides. And insurance companies are not in the habit of losing money, so these additional features tend to add significant cost.


Recall that an annuity is a stream of payments. But where does the stream come from? Money placed into a fixed or variable annuity can be annuitized thereby turning it into the stream of payments we discussed earlier.

Let me offer two words of caution here:

  1. Annuitizing any money whether in a pension plan, 401k, or variable annuity is generally an irrevocable decision.
  2. Annuitizing is generally not the same as exercising a guaranteed lifetime income or accumulation benefits available under a variable annuity contract riders.

Annuities can play a role in your financial plan, but you’ll need to dig into the details to see if they fit and how much they’ll cost.

We’ve only scratched the surface here and in future posts we’ll discuss variable annuity riders, fees and investment options, and variable annuity options available through fee-only investment advisors.

investing for retirement ebook ipad - McClain Lovejoy
investing for retirement ebook ipad - McClain Lovejoy
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