What Are Variable Annuity Subaccounts?

Variable annuities let people to put money into mutual funds, including stock funds, bond funds and money market funds, so the principal has the potential to grow but still enjoy certain tax advantages. Each fund in a variable annuity is called a subaccount. Here’s what you need to know about variable annuity subaccounts, their nature, fees and tax provisions.

Consider speaking with a financial advisor if you’re trying to determine how these annuities can play into your financial plan.

What Are Variable Annuity Subaccounts?

When you purchase a variable annuity, you choose the subaccounts in which your money will be invested. You can also decide how much to invest in each. For example, when buying a variable annuity you might choose to invest 65% of your money in a stock fund, 25% of your money in a bond fund and 10% in a money market fund. In such a case, the annuitant (the person who owns the annuity) would have three subaccounts.

Although variable annuity subaccounts contain investments that are identical to mutual funds, they don’t have a stock ticker you can search on an investment database to find information on the fund. In addition, because of their tax-deferred status, subaccounts may perform slightly differently when compared to their mutual fund counterparts.

Money that is withdrawn from a variable annuity before age 59 ½ is subject to a 10% penalty.

Variable Annuity Subaccount Fees

Variable annuities can offer long-term growth potential and retirement income, but they also come with layers of fees that can eat into returns. Subaccount fees, in particular, are tied to the investment options within your annuity and are often similar to mutual fund expense ratios. These fees typically cover the cost of professional management, administrative expenses and other operational costs associated with each subaccount.

Each subaccount inside a variable annuity is professionally managed, and those management services come at a cost. The fund manager’s fee, often called an expense ratio, can range anywhere from 0.5% to 2% per year depending on the investment strategy. Administrative costs are also built into the total expense, covering recordkeeping, reporting and other day-to-day operations that keep the subaccount running smoothly.

In addition to subaccount fees, variable annuities include mortality and expense risk charges, fees that compensate the insurer for the guarantees they provide. These may include death benefits or income guarantees, and they’re typically charged as a percentage of your account’s total value. While these features can add peace of mind, they increase overall costs, which can reduce your potential investment growth over time.

Because variable annuities are designed for long-term investment, even small differences in annual fees can have a significant impact over time. Higher costs mean less money compounding toward your future income stream. Comparing fee structures and understanding exactly what you’re paying for can help you make a more informed decision.

Fixed vs. Variable Annuities

The main distinction between fixed and variable annuities lies in how returns are generated and how much risk you’re willing to take. A fixed annuity offers a guaranteed interest rate, providing stable, predictable income over time. A variable annuity, on the other hand, allows you to invest in subaccounts that fluctuate with the market — which means your returns (and potential income) can rise or fall depending on performance.

Fixed annuities are often favored by conservative investors who prioritize security and guaranteed payouts. They function much like a savings account with higher yields, making them ideal for those nearing or already in retirement who want consistent income without worrying about market volatility. Variable annuities appeal to investors with a longer time horizon who are comfortable taking on risk in exchange for potentially higher growth.

With fixed annuities, the insurance company shoulders the investment risk — your return is locked in regardless of how the broader market performs. Variable annuities shift that risk to you, the investor, because your returns depend on the performance of the underlying subaccounts. While this can lead to higher earnings during strong market periods, it can also result in losses if markets decline.

Types of Variable Annuities

Variable annuities aren’t one-size-fits-all — they come in several forms designed to match different financial goals, time horizons and risk levels. Understanding the key differences between each type can help you choose an annuity that aligns with your retirement strategy and income needs. Here’s an overview of the main types of variable annuities and how each one works.

Deferred variable annuities: Deferred variable annuities are built for long-term growth. Your money is invested in subaccounts that grow tax-deferred until you begin withdrawals, often during retirement. This type allows your investment to compound over time and can later be converted into a steady income stream when you’re ready.
Immediate variable annuities: Immediate variable annuities start paying income shortly after you invest, usually within a year. You make a one-time lump-sum payment, and the insurer begins sending regular payouts based on the performance of your chosen subaccounts. These can provide quick income but come with fluctuating payments tied to market returns.
Qualified variable annuities: Qualified variable annuities are purchased with pre-tax dollars, typically through retirement accounts like an IRA or 401(k) rollover. You won’t pay taxes until you withdraw funds in retirement, which can help defer your tax burden while you’re still working. However, all withdrawals — including earnings — are taxed as ordinary income.
Non-qualified variable annuities: Non-qualified annuities are funded with after-tax dollars, offering tax-deferred growth on investment gains. When you withdraw funds, only the earnings portion is taxed, while your original contributions can be accessed tax-free. This structure can provide flexibility for investors who want to diversify their income sources in retirement.
Registered index-linked annuities (RILAs): RILAs are hybrid products that blend elements of fixed and variable annuities. They let you participate in market gains up to a cap while offering limited protection against losses. These can appeal to investors who want growth potential but prefer a degree of downside security.

Choosing the right variable annuity depends on your financial goals, investment timeline and comfort with market risk. Each type offers a different balance of growth potential, income flexibility and tax treatment. A financial advisor can help you evaluate these options and select the annuity structure that best fits your overall retirement plan.

Pros and Cons of Variable Annuities

When compared to fixed annuities, variable annuities have their own set of pros and cons.

Pros of Variable Annuities

Tax-deferred: Money in a variable annuity is tax-deferred, so you pay no tax until the money is withdrawn.
Customizable: Variable annuity subaccounts allow you to decide how to invest your money; you can pick and choose investments that align with your goals, risk profile and timeline.
Death benefit: If you die before the payout phase, there may be a guaranteed death benefit for your beneficiaries.

Cons of Variable Annuities

Market risk: Variable annuity subaccounts may expose you to market risk, particularly if you invest in stocks. Hence, you could lose money if equity markets doesn’t perform well.
Early withdrawal: Variable annuities are treated like retirement accounts, which means you can’t access your money before age 59 ½ without paying a 10% penalty.
Fees: Each subaccount charges a management fee, which is an addition to the fees imposed by the annuity. As a result, total fees on a variable annuity can be quite high.

Bottom Line

A variable annuity, sometimes called mutual funds wrapped in an annuity, allow you to invest a portfolio of subaccounts that can include investments such as stock funds, bond funds and money market funds. Because they let you invest in the market, variable annuity subaccounts give investors the chance to grow the value of their accounts. Investors may also have some choice over the subaccounts in their variable annuity. However, variable annuities also expose investors to market risk. Fees can also be quite high and you face an early withdrawal penalty if you take money out before age 59 ½.

Tips on Retirement

Deciding on the right investments that will help you reach your financial goals can be difficult. Speaking to a financial advisor might be the best way to help you figure it out. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Annuities can help you grow your investment over time, but it can be tough to know exactly how much you need. Use SmartAsset’s retirement calculator to better understand your retirement trajectory and how much you will have in retirement.
Investing can be a powerful tool to grow your wealth. Our investment calculator can help you understand how much your investments might grow over time.