What differentiates a variable annuity from a fixed annuity?

The differentiation between a variable annuity and a fixed annuity primarily rests on the nature of the payouts and how they are determined. In the case of a variable annuity, the payout amount is not fixed but varies based on the performance of the underlying investment options chosen by the policyholder. This means that the annuity's value can increase or decrease based on market conditions, leading to potential higher returns, but also increased risk.

In contrast, a fixed annuity provides a guaranteed payout, meaning that the policyholder receives a predetermined amount on a regular basis. This fixed payout does not fluctuate with market performance, offering stability and predictability.

Understanding this fundamental difference is crucial for investors when deciding between these two types of annuities, as the choice reflects their risk tolerance, investment goals, and the desire for growth versus security. The specified nature of variable annuities ties directly into the concept of risk and reward, providing potential for higher earnings correlated with market performance, which is why the correct answer focuses on this aspect.