Final answer:
The premium paid for a variable annuity, minus expenses, is converted into accumulation units during the investment phase. These units represent the annuity holder's investment share, which changes in value based on the performance of the underlying funds. Accumulation units are distinct from annuity units, which are related to the calculation of income payments during the distribution phase.
Step-by-step explanation:
The premium paid for a variable annuity, after deducting expenses, is converted into what are known as accumulation units. Variable annuities are investment products that merge the elements of tax deferral and potential for growth or income via investment options. The investor pays a premium that is invested in a range of securities based on the choices the holder makes. These securities often comprise mutual funds that match different investment strategies.
Throughout the accumulation phase of a variable annuity, the invested premium (minus any applicable fees or expenses) acquires accumulation units of the annuity. The value of these units fluctuates with the performance of the underlying investment options. Unlike a fixed annuity, which provides a guaranteed payout, the performance of a variable annuity's investments determines the amount of funds available upon withdrawal or annuitization.
In contrast, annuity units are used during the distribution phase of a variable annuity to determine the amount of each payment when the annuitant starts receiving income. It's important to differentiate between accumulation units, which represent your share of the investment during the accumulation phase, and annuity units, which determine the payout during the annuitization phase. Furthermore, the annuity value refers to the cash value of the annuity based on the performance of the investment options, while taxable gain represents the profit that is subject to income taxes upon withdrawal from the annuity.