Variable Annuity Pros and Cons: When They Make Sense

The important word in both columns is potential. Variable annuities are contracts, not a single standardized product. One contract can be materially different from another. The right decision depends on the exact benefits, costs, investment choices, rider rules, surrender schedule, tax status, and insurer behind the guarantees.

Investor.gov’s current variable-annuity guidance separates the product from an ordinary investment account by pointing to its insurance features, tax deferral, and ability to provide periodic income. Those insurance features are the reason to do the extra homework.

If you need the broader foundation first, my guide to how annuities work covers fixed, indexed, immediate, and variable contracts. Here, the narrower job is deciding whether a variable annuity’s insurance layer earns its cost.

1. Tax-Deferred Growth Can Matter in a Nonqualified Contract

In a nonqualified variable annuity, federal tax on investment earnings is generally deferred until money is distributed. You can also move among investment options within the annuity without creating a current federal taxable event each time you rebalance.

That can be useful in the right situation, but tax deferral is not the same thing as favorable tax treatment. Taxable gains distributed from the annuity are generally taxed at ordinary federal income-tax rates rather than long-term capital-gains rates. That tradeoff belongs in the comparison.

2. Lifetime-Income Features Can Transfer Longevity Risk

A variable annuity can be annuitized into periodic payments, and many contracts also offer optional living-benefit riders designed to support withdrawals for life under specific rules. For someone whose central problem is “How do I create income I cannot outlive?” that can be a legitimate insurance job.

But read the guarantee literally. A guaranteed lifetime withdrawal benefit is not necessarily a guarantee of your investment account value, and a rider’s benefit base is not automatically cash you can surrender for. The formula, withdrawal percentage, age bands, step-ups, investment restrictions, and rider charge all matter. My annuity riders guide goes deeper into those mechanics.

3. A Death-Benefit Feature Can Protect a Minimum Legacy

Many variable annuities include a death-benefit feature, and some offer enhanced benefits for an additional charge. Investor.gov notes that many contracts promise a beneficiary at least a specified amount if the owner dies before income payments begin, subject to the contract’s terms and prior withdrawals.

That can matter when leaving a minimum benefit is a real planning objective. It is much less compelling when the death benefit is merely used to make an expensive investment contract feel safer.

4. One Contract Can Combine Investment Choices and Insurance

For the right person, bundling market-based investment choices with insurance guarantees can simplify a difficult retirement-income problem. The same bundling creates the product’s biggest analytical challenge. If the investment, insurance, and contract rules are all discussed at once, it becomes easy to lose track of what each piece costs.

1. Several Fee Layers Can Stack Together

Variable annuities can include mortality and expense risk charges, administrative charges, expenses inside the subaccounts, and additional charges for optional riders. The SEC’s variable-annuity investor guidance tells investors to understand all charges because they reduce both account value and investment return.

There is no honest universal fee number that tells you whether your contract is expensive. The better question is, “What is my all-in annual cost for the exact investments and riders I plan to use?”

2. Surrender Charges Can Make a Change of Plan Expensive

The SEC says surrender-charge periods are often six to eight years and can sometimes last as long as ten years. The charge commonly declines over time, but the exact schedule, free-withdrawal allowance, and treatment of later purchase payments depend on the contract.

3. Tax Deferral Does Not Mean Better Tax Treatment

For a nonqualified annuity, a withdrawal before the annuity starting date is generally treated as coming from earnings first and then from your investment in the contract, with exceptions for certain older contracts. IRS Publication 575 explains that distinction and separately covers the taxation of periodic annuity payments.

The taxable portion is generally ordinary income. Most taxable distributions from nonqualified annuity contracts before age 59½ can also face an additional 10% federal tax unless an exception applies. That federal tax issue is separate from any surrender charge imposed by the insurance contract.

If your question is specifically about required minimum distributions, my guide to RMDs and nonqualified annuities owns that deeper tax distinction.

4. You Can Have Market Risk and Insurance-Company Risk at the Same Time

The subaccounts can lose value when markets fall. Separately, the insurance guarantees depend on the contract and the insurer’s ability to meet its obligations. That means “guaranteed” should always be followed by two questions. Guaranteed what, and guaranteed by whom?

5. Complexity Makes Bad Comparisons Easy

Two variable annuities can use different subaccounts, benefit bases, rider formulas, withdrawal rules, death benefits, surrender schedules, and fees. Comparing only the illustrated income number is not enough. Comparing only the investment return is not enough either.

The product has to be compared as a contract. That is why I care more about the questions you can answer than the number of glossy pages in the illustration.

That does not mean an annuity inside an IRA is automatically wrong. It means the justification must come from somewhere else. Maybe the contract’s lifetime-income guarantee solves a real retirement-income problem. Maybe a death benefit matters. Maybe another insurance feature fits the plan.

But if the only explanation is “you get tax-deferred growth,” stop. The IRA already provides the tax deferral.

Investor.gov warns that replacing an annuity can expose you to a surrender charge on the old contract and a new surrender-charge period on the replacement contract. A new contract can also change fees, guarantees, benefit bases, investment choices, and withdrawal rules.

If you already own a variable annuity, the question is not simply, “Is the new one better?” First document what the old contract still gives you. Older guarantees can sometimes be difficult or expensive to recreate.

RILAs have become a much larger part of the annuity market. LIMRA’s final 2025 sales report put RILA sales at $79.5 billion, up 20% from 2024, while traditional variable-annuity sales reached $63.1 billion, up 8%.

That is a market trend, not a recommendation. A newer contract category does not eliminate the need to compare the exact downside formula, upside limits, surrender rules, riders, and insurer.

If your primary objective is guaranteed income rather than market-linked accumulation, compare the contract with an immediate annuity. If you want a simpler interest-rate guarantee, compare it with the pros and cons of fixed annuities. The point is not that one product always wins. It is that alternatives should be matched to the same job.

Ask whether the exact contract solves a problem you actually have. Price the guarantee. Price the exit. Understand the tax treatment. Compare a simpler way to solve the same problem. If the variable annuity still earns its place after that, you have a reason to consider it. If it does not, the complexity was never the benefit.

For the broader retirement context, see my annuity do’s and don’ts for retirees.