As a retired financial planner with almost 30 years of experience, I’ve seen variable annuities (VAs) described as everything from a retiree’s silver bullet to a fee-laden trap. Variable Annuities are the financial world’s Swiss Army knife. Complex, with many moving parts, promising market-like growth with a safety net.
But here’s a hard truth you won’t hear in a sales pitch: The average variable annuity comes layered with fees that can easily total 2.5% or more annually. That’s a potential drag that could cost you hundreds of thousands in retirement.
The market itself is sending a clear signal. In the first half of 2025, sales of a newer, more flexible alternative called Registered Index-Linked Annuities (RILAs) surged 20% to a record $37 billion. Meanwhile, traditional VA sales, while rebounding, trailed at $30 billion.
So, is the traditional VA obsolete? Or is there a specific situation where it remains the right tool for the job?
This guide will cut through the noise. We’ll break down the real pros and cons, analyze the hidden fees, and give you a clear framework to determine if a VA, or its popular alternative, truly fits in your 2026 retirement strategy.
Key Takeaways: Your 60-Second Briefing on The Variable Annuity Pros and Cons
- Primary Benefit of a Variable Annuity:
Variable annuities offer a unique combination of direct market investment potential (through subaccounts) and insurance guarantees. Like a death benefit for heirs and optional lifetime income riders. - Biggest Drawback of Variable Annuities:
They are notoriously expensive. A combination of mortality & expense charges, administrative fees, subaccount fees, and rider costs can easily exceed 2.5%, significantly hindering long-term growth. - The 2025 Trend:
Investors are flocking to Registered Index-Linked Annuities (RILAs), a modern alternative offering downside protection with less complex fees, which are now outselling traditional VAs. - The Bottom Line:
A VA only makes sense for a small subset of long-term, conservative investors in high tax brackets who have already maxed out all other tax-advantaged accounts (like 401(k)s and IRAs) and whose primary goal is guaranteed lifetime income.
Key Takeaways Ahead
- Key Takeaways: Your 60-Second Briefing
- What is a Variable Annuity, Really? (Beyond the Jargon)
- The Pros: 4 Scenarios Where a VA Might Make Sense
- The Cons: The 5 Red Flags You Cannot Ignore
- Fee Breakdown: The Hidden Costs That Erode Your Growth
- Market Shift 2025: RILAs vs. Traditional Variable Annuities
- Who is a Variable Annuity Actually For? A Suitability Checklist
- Final Verdict & Your Action Plan
What is a Variable Annuity, Really? (Beyond the Jargon)
At its core, a variable annuity is a contract between you and an insurance company. It’s a dual-regulated product, overseen as a security by the SEC and FINRA, and as an insurance product by your state’s insurance commissioner.
🔍 Explained Simply
Think of a variable annuity as a personal pension plan you create with an insurance company. You invest money into market-based funds (“subaccounts”) for tax-deferred growth, and in return, the insurer provides certain guarantees, like a lifelong income stream in retirement.
Here’s the deal:
- You Invest: You pay the insurance company a lump sum or a series of payments.
- It Grows (Hopefully): Your money is invested in a portfolio of mutual-fund-like “subaccounts” that you choose. The value of your annuity rises and falls with the performance of these investments.
- It’s Tax-Deferred: You don’t pay taxes on any investment gains until you start taking withdrawals.
- You Get Payouts: Later, you can convert the annuity into a stream of regular income payments, a process called annuitization, which can last for the rest of your life.
Think of it as a private pension you fund yourself, wrapped inside an insurance policy. Read our recent article to learn all about What Is An Annuity?
The Pros: 4 Scenarios Where a Variable Annuity Might Make Sense
While the headwinds are strong, there are specific situations where a VA’s unique features provide real value.
1. You Crave Stock Market Growth with a Guaranteed “Floor”
Variable annuities allow you to participate in stock market gains through subaccounts. Unlike a direct stock portfolio, they come with built-in insurance features.
The most significant is the death benefit, which guarantees that if you pass away during the accumulation phase, your beneficiaries will receive at least the amount you originally invested, regardless of market performance.
This provides a psychological safety net.
2. You’ve Maxed Out Every Other Retirement Account
If you’re a high-income earner and have already contributed the maximum to your 401(k) and IRA, a VA offers another avenue for tax-deferred growth with no annual contribution limits.
This is its most common and legitimate use case: a tax-advantaged supplement for disciplined, high-net-worth savers.
💡 Michael Ryan Money Tip
A variable annuity should be the last tax-advantaged account you fund, not the first. Always maximize your 401(k) for the employer match and your Roth or Traditional IRA for lower fees before even considering an annuity for tax deferral.
3. Your #1 Fear is Outliving Your Money
The most powerful feature of an annuity is the ability to add optional riders for an extra fee. The most popular is a Guaranteed Lifetime Withdrawal Benefit (GLWB) rider.
This ensures you can withdraw a certain percentage of your initial investment every year for the rest of your life, even if the market tanks and your account value goes to zero.
Michael Ryan’s Take: I can’t overstate the psychological value of a guaranteed “paycheck” for some retirees. For clients whose deepest fear was running out of money, a GLWB rider on a portion of their portfolio provided the peace of mind to stay invested with the rest. It’s expensive peace of mind, but for some, it’s worth it.
4. You Want to Leave a Protected Legacy
The standard death benefit ensures your heirs get back at least what you put in. Many VAs also offer enhanced death benefits (for an additional fee) that can “step-up” the guaranteed amount to the highest value your account ever reached, locking in gains for your beneficiaries.
The Cons: The 5 Red Flags You Cannot Ignore
This is where the rosy picture gets complicated. The drawbacks of variable annuities are significant and are the primary reason for their waning popularity.
1. The Fees are Outrageously High
This is the single biggest issue. VAs are notorious for their layers of fees that create a constant drag on your returns. (More on this in the next section).
2. Your Money is Tied Up for Years
Most VAs come with a surrender period, which can be 7 years or even longer. If you need to withdraw more than a small, specified amount (usually 10%) during this period, you’ll be hit with a hefty surrender charge that decreases over time.
📉 Bad Advice to Ignore
A salesperson might tell you, “The surrender period doesn’t matter if you plan to hold it for the long term.” This ignores life’s unpredictability. An unexpected medical bill or family emergency can force a withdrawal, turning that long-term plan into a costly mistake.
Michael Ryan’s Take: I’ll never forget a client, ‘Susan,’ who planned to use her annuity for retirement but had to help her son with a down payment 3 years into her 7-year surrender period. The 5% penalty was a painful, multi-thousand-dollar lesson in just how illiquid these products are when life happens.
3. The Tax Treatment on Withdrawals is Unfavorable
While your money grows tax-deferred, all gains are taxed as ordinary income when you withdraw them, not at the lower long-term capital gains rates.
Furthermore, withdrawals are taxed on a “Last-In, First-Out” (LIFO) basis. This means you withdraw all of your taxable earnings first before you can access your non-taxable principal (your original contributions). This is a significant disadvantage compared to other investment accounts.
4. They Are Incredibly Complex
A variable annuity prospectus can be hundreds of pages long, filled with complex legal language and confusing fee tables. This complexity makes it difficult for even savvy investors to fully understand what they are buying.
You can find examples and guidance directly from regulators like the SEC.
5. There is No Step-Up in Basis for Heirs
Unlike a standard brokerage account, the death benefit paid to your beneficiaries does not receive a “step-up” in basis. This means your heirs will have to pay ordinary income tax on all the gains within the annuity.
Fee Breakdown: The Hidden Costs That Erode Your Growth
Let’s break down the layers of fees. Understanding this is critical to making an informed decision.
📊 Quick Stat
According to FINRA, the regulatory authority, total annual fees for a variable annuity can sometimes exceed 3%. On a $250,000 investment, that’s $7,500 per year in costs alone, significantly impacting your potential for compound growth.
| Fee Type | Average Annual Cost | What It Pays For |
|---|---|---|
| Mortality & Expense (M&E) | 1.25% | The insurance guarantees, like the standard death benefit. |
| Administrative Fees | 0.25% | Record-keeping and other administrative costs. |
| Subaccount Investment Fees | 0.50% – 2.00% | The expense ratios of the underlying mutual fund-like investments. |
| Optional Rider Fees | 0.75% – 1.50% | The cost for enhanced benefits like a GLWB or stepped-up death benefit. |
| Total Potential Annual Cost | 2.75% – 5.00%+ | A significant hurdle for your investments to overcome each year. |
Market Shift 2025: RILAs vs. Traditional Variable Annuities
The massive flow of funds into Registered Index-Linked Annuities (RILAs) shows a clear shift in consumer preference. So, what’s the difference?
- Traditional VA:
You are directly invested in the market through subaccounts. You get all the upside but are also exposed to all the downside, buffered only by your expensive insurance guarantees. - RILA (The Modern Alternative):
You are not directly invested. Instead, your returns are linked to the performance of a market index (like the S&P 500).- The Pro:
You get downside protection through a “floor” (you absorb losses only down to a certain point, e.g., -10%) or a “buffer” (the insurer absorbs the first X% of any loss, e.g., the first 10%). - The Catch:
Your upside is limited by a “cap” (e.g., your maximum gain is 12% even if the market goes up 20%) or a “participation rate.” - The Big Win:
RILAs typically have much lower (or even zero) base fees compared to traditional VAs, as the protection is built into the crediting formula rather than charged as a separate rider.
- The Pro:
Insider Insight: As Keith Golembiewski of LIMRA noted, “Elevated market volatility makes RILAs appealing for protected growth with attractive caps and participation rates.” For many pre-retirees, the RILA offers a more transparent and cost-effective way to get the “growth with a safety net” they desire.
Who is a Variable Annuity Actually For? A Suitability Checklist
Before even considering a variable annuity in 2026, you should be able to check all of the following boxes:
Before even considering a variable annuity in 2026, you should be able to check all of the following boxes:
- [ ] You have a very long time horizon (10+ years). This is necessary to ride out market cycles and overcome the high fees.
- [ ] You are in a high federal and state income tax bracket. The tax-deferral benefit is most valuable when you can defer taxes at a high rate.
- [ ] You have already maxed out your 401(k) and IRA contributions for the year. These vehicles offer similar tax benefits with much lower costs.
- [ ] Your primary goal is a guaranteed income stream in retirement that you cannot outlive. You are willing to pay a premium for this guarantee.
- [ ] You do not anticipate needing to withdraw a large portion of the money during the surrender period (typically 7+ years).
🤔 Things to Ponder
If you checked every box, a VA might be a tool to investigate further. If you only checked a few, it’s a strong sign that your financial goals can likely be met more efficiently with lower-cost alternatives like a diversified portfolio of ETFs or a simpler fixed-indexed annuity.
If you cannot confidently check every single one of these boxes, a traditional variable annuity is likely not the right financial tool for you.
Final Verdict & Your Action Plan
For the vast majority of investors in 2026, the high fees, unfavorable tax treatment on gains, and complexity of traditional variable annuities make them a suboptimal choice. The rise of lower-cost and more transparent RILAs has provided a better alternative for those seeking a balance of protection and growth.
However, for a niche group of high-income, tax-sensitive investors who have exhausted all other retirement savings options and whose primary, non-negotiable goal is a lifelong income guarantee, a carefully selected, low-cost VA can still play a role within a diversified portfolio.
Your Action Plan:
- Confirm You’ve Maxed Out Other Options:
Before looking at any annuity, ensure you are maximizing contributions to your 401(k), IRA, or Roth IRA. Find more in our Retirement Planning Guide. - Request the Full Prospectus:
If you are considering a specific VA, demand the full prospectus from the advisor. Go directly to the fee table. If the total annual fees exceed 2%, ask for a detailed justification. - Compare with a RILA:
Ask the advisor to provide a side-by-side illustration of the VA against a modern RILA. Compare the caps, buffers, and internal costs. - Consult a Fiduciary:
Get a second opinion from a fee-only fiduciary financial advisor who is not compensated by selling the product. For more information on fees, see our guide on Financial Advisor Fees.
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Disclaimer: This article is for informational purposes only and does not constitute financial or investment advice. Consult with a qualified and licensed financial professional before making any investment decisions.
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Note: The content provided in this article is for informational purposes only and should not be considered as financial or legal advice. Consult with a professional advisor or accountant for personalized guidance.
