Variable annuity pros and cons are not really a contest between “market growth” and “high fees.” The better question is whether the specific insurance guarantees in the contract are valuable enough to justify its costs, restrictions, and tax treatment.
After nearly 30 years as a financial planner, that is the distinction I would want you to make before signing anything. A variable annuity can be useful when you genuinely need a lifetime-income or death-benefit guarantee and can live with the contract for years. If you mainly want tax-deferred investing, market exposure, or a place to hold mutual-fund-like investments, there are usually simpler ways to get those things.
Quick Answer
A variable annuity is an insurance contract whose account value can rise or fall with investment subaccounts. Its potential advantages include tax-deferred growth, optional lifetime-income guarantees, and death-benefit features. Its disadvantages can include higher ongoing expenses than a typical mutual fund, surrender charges, market risk, complexity, and ordinary-income tax treatment on taxable gains. If the contract is inside an IRA or 401(k), the annuity itself adds no extra federal tax deferral.
Key Takeaways Ahead
What a Variable Annuity Actually Does
A variable annuity is a contract with an insurance company. During the accumulation phase, you allocate money among investment options called subaccounts, which commonly hold stock, bond, and money-market portfolios. Your account value changes with those investments, so you can gain money or lose money.
What makes the product different from an ordinary investment account is the insurance layer. FINRA’s annuity guidance identifies three common variable-annuity features: tax-deferred earnings, a death benefit, and payout options that can provide guaranteed lifetime income. Variable annuities are securities as well as insurance products, so they are subject to securities regulation in addition to state insurance oversight.
If you need a broader refresher on fixed, indexed, immediate, and variable contracts, start with my understanding annuities. Here, we are staying focused on one decision: whether the extra insurance features of a variable annuity are worth the extra contract complexity for you.
The Pros: 4 Benefits That Can Justify a Variable Annuity
The strongest case for a variable annuity is not “the market might go up.” You can get market exposure without an annuity. The case becomes stronger when one of the contract’s insurance features solves a retirement problem you actually have.
1. Tax-Deferred Growth Outside a Retirement Plan
Money in a nonqualified variable annuity can grow without current federal income tax on annual investment gains. There is also no annual contribution limit imposed on a nonqualified annuity the way there is on an IRA or 401(k).
But this benefit is easy to oversell. Investor.gov specifically warns that an annuity held inside a tax-advantaged retirement plan provides no additional tax advantage from the annuity wrapper. That makes “Why do I need the annuity inside this IRA?” one of the most important questions you can ask.
2. Lifetime-Income Guarantees Can Transfer Longevity Risk
A variable annuity can be annuitized into periodic income, and many contracts offer optional living-benefit riders designed to support lifetime withdrawals under stated contract rules. That can be valuable if your biggest retirement risk is not market volatility itself, but the possibility of outliving the assets you are willing to spend.
The key is to understand exactly what is guaranteed. A guaranteed lifetime withdrawal benefit, or GLWB, is not the same thing as guaranteeing your account value or guaranteeing a particular investment return. My Annuity Riders goes deeper into how these add-on guarantees change the contract.
Michael Ryan’s Take: I have seen the psychological value of a retirement “paycheck” matter as much as the spreadsheet. For someone whose fear of running out of money could otherwise push them into an investment plan they cannot stick with, paying for a well-understood guarantee can be rational. The mistake is paying for three guarantees when you only needed one.
3. A Death-Benefit Floor Can Protect a Minimum Legacy
Many variable annuities include a death benefit. The SEC’s variable-annuity guidance explains that a common design pays the beneficiary the greater of the account value or a guaranteed minimum, such as purchase payments minus prior withdrawals. Some contracts offer stepped-up death benefits for an additional charge.
That can matter if leaving a minimum amount is a real planning objective. It is much less compelling when the death benefit is simply being used to make a high-cost investment contract sound safer than it is.
4. The Contract Can Bundle Investment and Insurance Decisions
For the right person, having investment choices and retirement-income guarantees in one contract can simplify a complicated planning problem. That convenience has value. It also creates the central risk of the product: because everything is bundled together, it can be hard to see what each benefit costs and whether you would buy it on its own.
The Cons: 5 Costs and Risks to Price Before You Buy
Here is where variable annuity decisions usually go wrong: the buyer understands the benefit in plain English but sees the cost only as a line in a prospectus. Put those two on the same page before you decide.
1. Ongoing Expenses Can Create a High Hurdle
Variable annuities can layer mortality and expense risk charges, administrative expenses, underlying fund expenses, and charges for optional riders. FINRA says a variable annuity’s annual expenses are likely to be much higher than those of a typical mutual fund. That does not mean every contract is overpriced. It means “What is my all-in annual cost?” deserves a precise answer.
2. Surrender Charges Can Turn a Change of Plan Into a Costly Exit
SEC variable-annuity guidance says surrender periods commonly run six to eight years and can sometimes last as long as ten years. A contract may allow some annual withdrawals without a surrender charge, but the exact free-withdrawal rule and charge schedule are contract-specific.
Watch the “You’re Holding It Long Term Anyway” Argument
A long time horizon does not make liquidity irrelevant. Retirement plans change. Family needs change. Better products appear. If getting out of the contract is expensive for years, that restriction belongs in the purchase decision today.
Michael Ryan’s Take: One lesson I learned with clients is that surrender schedules feel theoretical right up until life changes. The useful question is not, “Do I expect to hold this?” It is, “What would it cost me if I’m wrong?”
3. Tax Deferral Does Not Mean Better Tax Treatment
For a nonqualified annuity, investment gains generally come out taxable as ordinary income rather than long-term capital gains. IRS Publication 575 also explains that a nonperiodic withdrawal from a nonqualified annuity before the annuity starting date is generally allocated to earnings first and then to your investment in the contract, subject to exceptions such as certain older contracts.
Most taxable distributions from nonqualified annuity contracts before age 59½ can also face a 10% additional federal tax unless an exception applies. The tax rules differ for qualified retirement plans and for annuitized payments, so do not apply the nonqualified “earnings first” rule to every annuity distribution.
If required minimum distributions are part of your question, the answer depends on whether the annuity is qualified or nonqualified. I cover that distinction separately in my Do Non Qualified Annuities Have Rmds.
4. Complexity Makes Bad Comparisons Easy
A variable annuity is not one product. Two contracts can have different subaccounts, rider formulas, benefit bases, surrender schedules, withdrawal rules, death benefits, and expenses. Comparing only the illustrated income number or only the account return can hide the tradeoff that matters most.
5. The Guarantee Depends on the Contract and the Insurer
Your subaccount investments carry market risk. Insurance guarantees depend on the terms of the contract and the insurer’s claims-paying ability. The SEC specifically tells investors to consider the financial strength of the insurer when evaluating benefits that exceed the value of the underlying investment account.
Variable Annuity Fees: Read the Contract, Not the Pitch
There is no honest universal “average fee” that tells you whether the contract in front of you is expensive. Your job is to identify every layer that applies to your contract and translate the percentages into dollars.
A Better Fee Question
Ask for the prospectus and write down the mortality and expense charge, administrative charge, underlying investment expenses, every rider charge, and the surrender schedule. Then ask the advisor to show the all-in annual cost in both a percentage and dollars at your proposed account value.
| Cost or Restriction | What Current SEC Guidance Says | What You Should Verify |
|---|---|---|
| Mortality & expense risk charge | The SEC gives 1.25% per year as a typical example. | Your contract’s actual percentage and what insurance risks/features it pays for. |
| Administrative fees | May be a flat charge or a percentage; the SEC gives about 0.15% as a typical percentage example. | Flat account fee, percentage charge, and any waivers. |
| Underlying fund expenses | You indirectly pay the expenses of the underlying investment options. | Expense ratio for the subaccounts you actually plan to use. |
| Optional rider charges | Enhanced death benefits, income benefits, and other features often carry extra charges. | Each rider’s annual charge, benefit formula, and whether you truly need it. |
| Surrender charge | Commonly applies for six to eight years and sometimes up to ten years. | Year-by-year schedule, free-withdrawal amount, and whether new purchase payments restart a charge period. |
That fee table is more useful than a scary headline number because it forces the sales conversation back to the actual contract. If someone cannot show you the all-in cost clearly, that is information.
Variable Annuity vs. RILA: A Different Tradeoff, Not an Automatic Upgrade
Registered index-linked annuities, or RILAs, have grown rapidly, but “newer” does not automatically mean “better.” A traditional variable annuity invests through subaccounts, so your account value generally participates directly in the performance of those investment options. A RILA links returns to an index under a contract formula that can limit losses and gains.
| Feature | Traditional Variable Annuity | RILA |
|---|---|---|
| How returns are determined | Performance of selected subaccounts. | Performance is linked to an index under the contract’s crediting formula. |
| Downside | Account value can fall with the selected investments. | A buffer or floor can limit part of the downside, but losses are still possible. |
| Upside | Generally reflects subaccount performance after contract and investment expenses. | Often limited by a cap, participation rate, spread, or another contract formula. |
| Main comparison question | Are the investment choices plus insurance guarantees worth the costs? | Is the defined downside protection worth giving up part of the upside under the current terms? |
The market has clearly moved toward RILAs. LIMRA’s final 2025 sales report put RILA sales at $79.5 billion, up 20% from 2024, versus $63.1 billion for traditional variable annuities, which also grew 8%.
That is a market trend, not a recommendation. FINRA notes that RILAs can have complex structures with upside limits and downside protection. Compare the exact cap, participation rate, buffer or floor, surrender rules, riders, and insurer before deciding that a RILA is the cheaper or safer answer.
Who Should Consider a Variable Annuity? Use This 7-Question Test
Do not start with “Is a variable annuity good?” Start with the contract you were offered and answer these seven questions.
The 7-Question Variable Annuity Contract Test
- What exact problem am I solving? Lifetime income, a minimum legacy, tax deferral outside retirement accounts, or something else?
- Which guarantee solves that problem? Name the rider or contract feature. If you cannot name it, you probably cannot price it.
- What is the all-in annual cost? Include contract expenses, underlying investments, and every rider you plan to keep.
- What happens if I need out early? Write down the surrender schedule, free-withdrawal rule, and any benefit reduction caused by withdrawals.
- Where is the annuity being held? If it is inside an IRA or 401(k), tax deferral is not an extra benefit of the annuity itself.
- What am I giving up? Compare liquidity, investment flexibility, tax treatment, upside, and estate consequences with the best realistic alternative.
- Would I still buy this if the illustration disappeared? The contract language, not the sales illustration, determines what you own.
Here is my practical rule: a variable annuity becomes more defensible when you can point to a specific insurance guarantee you value, understand its price, expect to keep the contract long enough for surrender restrictions not to drive the decision, and have compared it with simpler ways to solve the same problem.
It becomes much harder to justify when the main selling point is simply “tax-deferred market growth,” especially inside an already tax-advantaged retirement account.
Bottom Line: Buy the Contract, Not the Pitch
Variable annuities are not obsolete, and they are not automatically bad investments. They are specialized insurance contracts. For someone who values a specific lifetime-income or death-benefit guarantee enough to pay for it, understands the restrictions, and can hold the contract for the intended horizon, a variable annuity can have a legitimate role.
For someone who mainly wants market exposure or tax deferral, the contract often adds complexity before it adds value. That is why I would not ask an advisor, “Is this a good annuity?” I would ask, “Show me the problem this contract solves, the exact guarantee that solves it, and every dollar I pay to get that guarantee.”
Your Action Plan Before You Buy, Exchange, or Keep a Variable Annuity
- Get the current prospectus and contract summary. Do not rely on the illustration alone.
- Build a one-page cost sheet. List M&E charges, administrative fees, subaccount expenses, rider charges, surrender charges, and any other contract costs.
- Write the guarantee in one sentence. If you cannot explain what is guaranteed, when it applies, and what can reduce it, you are not ready to buy it.
- Compare the best alternative that solves the same problem. That might be a simpler investment portfolio, a different annuity type, or a separate insurance solution. Compare outcomes and restrictions, not product labels.
- Get an independent second look when the decision is material. A fee-only fiduciary who is not being paid to sell that contract can help you pressure-test the assumptions and tradeoffs.
Primary Sources Used
Disclaimer: This article is for educational purposes only and is not individualized investment, tax, legal, or insurance advice. Variable annuity terms vary by contract, insurer, rider, tax status, and state. Review the current prospectus and contract, and consult qualified professionals when appropriate for your situation.
