A variable annuity is an insurance company product designed to allow you to accumulate retirement savings. When you purchase a variable annuity, either with a lump sum or over time, you allocate the premiums you pay among the various separate account funds offered in your annuity contract. The tax-deferred return on your variable annuity fluctuates with the performance of the underlying investments in your separate account funds, sometimes called investment portfolios or subaccounts.
You may purchase qualified variable annuities, which are offered as options within an employer sponsored retirement savings plan, or nonqualified variable annuities. Nonqualified annuities are those you purchase on your own, often to supplement other retirement savings. You can also choose an individual retirement annuity, which resembles an individual retirement account except that the underlying investments are separate account funds.
Among the appeals of both qualified and nonqualified variable annuities is the promise of a stream of income for life if you annuitize the assets in your account, and the right to make tax-exempt transfers among separate account funds. If you purchase a nonqualified annuity, there are no federal limits to the annual amounts you can invest, no requirement that you purchase the annuity with earned income, and no minimum required withdrawals beginning at 70½. However, with both types of variable annuities, withdrawals before you reach age 59½ may be subject to a 10% early withdrawal tax penalty.