Is a Variable Annuity a Good Idea?

Variable annuities offer strong growth potential and considerable risk all at once. The returns you earn through a variable annuity are based on the performance of an investment portfolio. However, this means you risk losing money. Variable annuities, in particular, have a few limitations on how much you can earn, making them undoubtedly enticing. Whether a variable annuity is a good idea for you depends on these factors and whether they fit your needs.

If you have specific questions about annuities or retirement planning, reach out to a financial advisor.

How Does a Variable Annuity Work?

A variable annuity pays an insurance company upfront for regular payments in the future. By purchasing an annuity, you enter into an insurance contract that provides retirement income based on how your investments perform.

All annuities have two components:

• The principal you pay into it
• The returns on that principal 

Generally, you pay a lump-sum premium for the policy, or you pay over time.

These deferred annuities mean buyers typically wait years before taking payments. Instead, you invest the funds in your variable annuity in one or more funds. Most of these are mutual funds focusing on specific areas of the market.

The value of your account can rise and fall with the market. You may lose money, but you might also earn quite a bit. This differs from a fixed annuity, which operates more like a certificate of deposit (CD) and earns a set interest rate.

Once you retire, you can turn your principal and earnings into a retirement income stream for a set period of time or for life. If you die before you annuitize and receive all the payments of your annuity, the insurance company will typically guarantee a death benefit payment to your beneficiaries of at least what you put in, minus any withdrawals and taxes.

In exchange for all these benefits, however, are steep fees and costs.

Variable Annuity Costs

More specifically, variable annuities have the most extensive fee structure of any annuity type. They often feature some combination of contract fees, investment fees and mortality and expense risk fees.

Total fees can have a significant impact on your returns, ranging from 2% to 3% or higher. ¹ If you have a $100,000 variable annuity with an annual 3% fee, you will pay $3,000 in fees each year. If your annuity returns 5.55% in a given year, you would only see a net return of 2.55%, or $2,550 after fees.

These charges can add up over time, taking away from your potential growth. However, you’re betting that you’ll outperform those extra costs so you still come out ahead.

To protect against losses, an insurance company offers guarantees for an additional cost. For example, you may pay extra for an annuity rider that locks in earnings for 10 years. You include this in your calculation when you annuitize.

These riders allow you to customize your contract so it better fits your plan.

Benefits of Variable Annuities

There are many pros and cons to annuities and, more specifically, to variable annuities.

Higher Potential Earnings

The biggest benefit of a variable annuity is the potential growth you can earn.

Compared to other types of annuities, a variable annuity can offer the best possible rate of return. This is because your money is in the markets.

Tax-Deferred Growth

Another benefit, which applies to all annuities, is the tax-deferred growth. This means the annuity taxes you would have paid to the IRS remain in your account and continue to grow.

You won’t owe income taxes until you make a withdrawal or start receiving payments from your variable annuity.

Lifetime Income

As with all annuities, a variable annuity offers a protected lifetime stream of income. For many, the knowledge that they won’t outlive their money gives them great peace of mind.

If you live longer than the actuaries predict and your account empties, the insurance company will still send you regular payments for as long as you live.

Protected Funds

The money in an annuity is protected from any creditors you may have, since the insurance company holds it. This makes an annuity one of the safest investments available.

Talk to a financial advisor for annuities to better understand if this is the right fit for you.

Drawbacks of a Variable Annuity

Before you rush to buy a variable annuity, there are drawbacks to this retirement savings vehicle to consider.

Overall Cost

A variable annuity’s biggest disadvantage is its cost because it can charge high fees.

This can include several types of annuity fees:

• Administrative fees
• Fees for special features
• Mutual fund expenses
• Sales commissions

When you add up these fees, variable annuities can be a pricey place to store your money.

Risk Fees 

There is also the mortality and expense (M&E) risk charge.

This annual fee is generally around 1.25% of your account value and accounts for the insurer’s risk of insuring your money.

Low Return Potential

A variable annuity may provide a lower return than the other kinds of annuities.

It all depends on the markets. If they’re down, so is your money.

Lack of Access

If you have yet to reach retirement, variable annuities - or all annuities for that matter - are virtually inaccessible. This is due to the surrender charges that insurance companies institute in these contracts.

Any withdrawals you make during that time that exceed the allotted amount will incur an additional charge, typically around 7%. ²

Variable Annuity vs. Fixed Annuity

Returns

While a variable annuity earns returns through investment performance, a fixed annuity has a specific interest rate pre-set by the insurer. The market may also dictate the quality of these fixed rates.

A standard interest rate likely won’t ever outperform investments. This is because mutual funds and other securities have exponential growth opportunities, whereas the fixed-rate market is considerably more stagnant. 

In good market conditions, a fixed annuity’s interest rate may hover around 3%. However, in 2026, rates were much higher. By early June, the best fixed annuities had rates topping 7.5%. ³

Risk

For many investors, the appeal of a fixed annuity boils down to risk.

There’s minimal volatility in the fixed-rate market. This can be especially enticing for those nearing retirement with a sizable savings pool.

Fees

Fixed annuities often have no annual fees whatsoever. On occasion, an insurance company may allow you to buy an extra rider.

However, this is very different from variable annuities, which charge a multitude of fees.

Taxation

Ultimately, variable and fixed annuities are versions of the same thing, so they share many of the same benefits. Tax-deferred growth is perhaps the most important among these similarities.

With both annuities, your funds grow without incurring income taxes. Then, once you retire, you pay income taxes on your withdrawals.

Death Benefits

An additional benefit is the ability to add death benefits. This provides protection for the contract owner’s assets in both cases should they pass away earlier than expected.

These are available for both fixed and variable annuities during a contract’s accumulation period.

Variable Annuity Taxes

Tax-deferred growth is one of the most popular benefits of a variable annuity, but the tax picture at withdrawal is more complicated than it first appears.

There are no taxes on your earnings each year. However, withdrawals are subject to ordinary income tax, not the lower long-term capital gains rate.

For investors in higher tax brackets, this distinction matters:

• The same investment you hold in a taxable brokerage account for more than a year would be taxed at capital gains rates, which top out at 20% for most high earners.
• Variable annuity withdrawals use ordinary income tax rates, which can reach 37%.

Withdrawals before age 59½ also trigger a 10% early withdrawal penalty in addition to ordinary income taxes. This same penalty applies to early withdrawals from a 401(k) or IRA.

Once you annuitize and begin receiving regular payments, the IRS applies what’s called the exclusion ratio. This determines two things:

• What portion of each payment represents a return of your original principal, which is not subject to tax
• What portion represents earnings, which is subject to tax

Your insurance company will provide this calculation, but it’s worth understanding before you commit to a payout structure.

Surrender Charges: How Long Is Your Money Locked Up?

Most variable annuities come with a surrender period, typically five to 10 years.

If you withdraw more than a set amount during this time, you trigger a surrender charge. These charges usually start between 7% and 10% in the first year and decline by roughly one percentage point each year until they reach zero.

For example, a contract with a seven-year surrender schedule might charge 7% in year one, 6% in year two and so on. If you withdraw a large sum in year two, you could lose a meaningful portion of it to fees before taxes even apply.

Most contracts allow you to withdraw a certain percentage of your account value each year, often 10%, without triggering the charge. However, for investors who need access to their money before the surrender period ends, getting out of an annuity represents a real constraint.

Before purchasing a variable annuity, know exactly how long the surrender period lasts and what the charge schedule looks like, as well as what your annual free withdrawal allowance will be.

How to Evaluate a Variable Annuity Before You Buy

Variable annuities must provide a prospectus, and it is well worth your time to read it carefully before signing anything.

Fees

Total annual fees are the most important number.

Add up the mortality and expense risk charge, the administrative fee and the expense ratios of the sub-accounts you plan to invest in. A contract with a 1.25% M&E charge, a 0.25% administrative fee and sub-account expenses averaging 0.75% is costing you 2.25% annually before any rider charges.

That is money coming directly out of your returns every year.

Sub-Accounts

Sub-account options vary significantly by contract.

Some offer a broad range of low-cost index fund options. Others are limited to actively managed funds, which have higher internal expenses.

The quality and cost of what you can invest in matters as much as the contract terms themselves.

Riders

If you are considering an optional rider, such as a guaranteed lifetime withdrawal benefit or an accelerated death benefit, carefully compare the cost to the benefit. Riders typically add 0.5% to 1% or more to your annual fees.

Model what the rider needs to deliver in order to justify that ongoing cost given your age, health and financial situation.

Compensation

Finally, ask the person selling you the annuity what they make.

Variable annuity commissions can be substantial, creating an incentive to recommend products that may not be best. An advisor who charges a flat fee or hourly rate has less reason to favor one product over another.

Variable Annuities Inside a Retirement Account

One of the most common and costly mistakes investors make is purchasing a variable annuity inside an IRA or 401(k).

The problem is straightforward: IRAs and 401(k)s are already tax-deferred. Wrapping a variable annuity inside one of these accounts does not add any additional tax benefit, because the account itself already provides it.

You end up with the fee structure of a variable annuity without its primary advantage. The mortality and expense charges, administrative fees and sub-account expenses still apply, and you are paying them for a benefit you already have.

There are narrow circumstances in which this arrangement may make sense. One example is when the annuity offers a specific guaranteed income rider that isn’t available elsewhere. However, these cases are exceptions.

If someone is recommending a variable annuity for your IRA or 401(k), ask specifically what benefit the annuity wrapper is adding beyond what the account already provides.

Alternatives Worth Considering

A variable annuity is not the only way to pursue tax-deferred growth, market exposure or guaranteed retirement income. Depending on your goals, these alternatives may accomplish the same objectives at lower cost:

• Low-cost index fund. Low-cost index funds in a taxable brokerage account provide full market exposure. There is no surrender period and no M&E charges, and you can access your money at any time. Gains you hold longer than a year are subject to capital gains tax rates rather than ordinary income rates, giving many investors a meaningful advantage.
• Roth IRA. A Roth IRA offers tax-free growth and tax-free withdrawals in retirement with no required minimum distributions (RMDs). Contribution limits apply, but for investors who qualify, a Roth IRA maintains tax efficiency at no additional cost.
• Fixed indexed annuity. A fixed indexed annuity offers market-linked growth with downside protection and typically lower fees than a variable annuity. You won’t capture full market gains, but you also won’t lose principal in a down year. For investors seeking growth potential without full market risk, this may be a middle ground worth exploring.
• Immediate annuity. If guaranteed lifetime income is your primary goal, an immediate annuity for retirement converts a lump sum into a predictable income stream. With its simpler fee structure, it can be ideal for anyone whose main concern is not outliving their savings rather than growing them further.

Is a Variable Annuity Right for You?

A variable annuity can appeal to investors who want the potential for market-driven growth along with tax-deferred earnings:

• Risk. Because returns are tied to underlying investment options like mutual fund–like subaccounts, these annuities offer more upside than fixed annuities. However, they also bring greater risk.
• Costs. Costs are a major factor in determining whether a variable annuity makes sense. Fees for mortality and expense charges, investment management and optional riders can be high. Over time, they may significantly reduce net returns compared to other investment vehicles.
• Time horizon and risk tolerance. Variable annuities are generally better for long-term investors who can withstand market fluctuations. It’s important that you don’t need immediate access to your money, since early withdrawals may trigger surrender charges and tax penalties.
• Optional protections. For some investors, the optional guarantees that variable annuities offer, such as lifetime income riders or death benefits, can provide peace of mind. Others may achieve similar goals more efficiently through a diversified investment portfolio or other retirement accounts.

Ultimately, deciding whether a variable annuity is a good idea depends on how it fits into your broader financial plan.

Bottom Line

Variable annuities can be pricey, so some investors may prefer to invest independently through a brokerage account. Although you’ll miss out on the tax-deferred growth, your fees will be much lower. Then when the time comes to retire, you can buy an immediate annuity if you want the lifetime income stream. If you’re still not sure, a financial advisor can help you make that decision.

Tips for Retirement Planning

• Purchasing an annuity can help save for retirement, but so can 401(k)s and IRAs. If you need help putting together a large-scale retirement plan, you can consider reaching out to a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• The two main retirement accounts most Americans own are 401(k)s and IRAs. To figure out which is best for you, take a look at SmartAsset’s guide to IRAs vs. 401(k)s.

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