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Variable Annuities: Are They Worth It?

Posted on June 30, 2021 by Gregg Brant

by Gregg Brant

As you approach retirement, a question you might be asking yourself is “Should I put my retirement assets in an annuity”. There are three main types of annuities: variable, fixed-indexed and fixed. In this article we are going to explain what makes variable annuities unique and their pros and cons.

A variable annuity is typically setup by depositing a lump sum from another retirement account, like a 401(k) or 457(b), or by funding the account with after-tax dollars, such as money in your checking account and are usually structured as a deferred annuity where you delay receiving income payments from your contract until some point in the future, allowing time for your balance to grow. They can also be setup as an immediate annuity where you start collecting payments immediately after funding the conract.

Annuities are insurance vehicles. Insurance is a contract between two parties where the purchaser pays a “premium”  in exchange for “guarantees” against risk. The insurance company then takes those premiums and using the laws of large numbers, pools risk against other insureds.

Variable annuities are a little different than fixed and fixed-indexed annuities where the funds that are paid to the insurer are invested inside the company’s general account. With a variable annuity, your money is held in a separate account and you have the opportunity to allocate your investments to a limited selection of variable sub-accounts controlled by the insurance company.. These sub-accounts invest your allocated premiums in their underlying portfolios of stocks, bonds and other marketable investments.. The value of your annuity will fluctuate based on the market performance of the investments no different than a portfolio of ETF’s or Mutual Funds.  

Benefits of a Variable Annuity

If your investments do well, a variable annuity could earn a higher return compared to other types of annuities. They can be an effective way to grow your savings long-term and protect against inflation.

Investment gains in a variable annuity are tax-deferred, meaning you don’t owe taxes until you take money out of the account. This is the same benefit that you would get in a 401(k) or an individual retirement account (IRA).WARNING: Be careful about allocating “extra” after-tax money to these vehicles as while it creates a tax shelter for deferring taxes, when you pull money out later in life, those funds will be be subject to a LIFO (last in first out) tax treatment where there is a higher tax liability (at your marginal rate) than what capital gains would be if they were not invested in an annuity.

Variable annuities come with all sorts of “riders” or “options/benefits” that can be added to the base contract at an additional cost (usually they are costly). For example, there are lifetime income guarantees, return of premium at death guarantees, and others.  This can provide added comfort when you’re investing your life savings, but frequently they are expensive and are hardly ever used.

Drawbacks of a Variable Annuity

Variable annuities do not offer guaranteed investment returns.  This is a common misconception, Annuity salepeople typically market and sell these annuities on the basis of a guarantee built into the annuity in the range of 4% – 6%.  This “guarantee” is only on the Income Account Value if you paid for the Income rider and not actually on your Account Value or real money. If your investments do poorly, it’s possible your balance may not grow or may even lose money. We see this frequently due to poor investment options in the annuity and high expenses (that are not very transparent!).

The fees on a variable annuity can be significantly higher than on other types of annuities. They also trump fees you would pay if you invested in similar securities on your own because you’re paying a combination of both investment fees and insurance expenses.

Variable annuities usually come with a surrender charge that lasts for five to ten years. If you try to take out a lump sum withdrawal greater than the free withdrawal amount allotted, or cancel your contract before then, you will owe a substantial penalty, normally not to exceed 10% (plus taxes!).

Each month or quarter, your insurance company will debit your cash value to pay the policy’s monthly charges.  According to Annuity.org the average variable annuity charges total 2.3% per year, though these can eclipse 3.5% depending on your policy.  This average includes very low-cost variable annuities as well as variable annuities without riders.  It is not uncommon to see the total charges go north of 3.5% if the client elects multiple riders to get the “guarantees” on their income and death benefit. This percentage consists of several fees your annuity company deducts from your balance every year (see breakdown below).

Variable Annuity Cost Breakdown

FEE 1-

The Mortality Expense (M&E) charge compensates the annuity company for running the contract and taking on the risk of making sure you get the future annuity payments. It could also cover the agent’s commission for selling you the annuity. Typically the commissions for these products are between 6% and 10% of the initial premium (yes, that means if you put in $500k the “salesperson” will earn between $30,000 and $50,000 one-time, with little incentive to help you long term).

FEE 2-

The annuity company may also charge an additional fee for their administration expenses. This could be a small percentage of your account balance.FEE 3-

The investment funds in the variable annuity may also charge their own annual fee, like the expense ratio on a mutual fund. Variable Annuity Sub-Account mutual fund fees vary significantly depending on the types of investments and strategy.FEE 4-

You could add extra benefits to your variable annuity, known as riders. For example, you could purchase a rider to guarantee that you will keep receiving lifetime income even if your investment balance runs out of money. In exchange, you need to pay an additional fee each year for the rider. If you purchase an income rider typically the fees are based on the income account value which often is significantly higher than the actual account value or contract value, thus driving the fees/expenses up even higher.

If you need to withdraw a substantial amount—or all—of your money before your surrender period, you will face the applicable surrender charges noted in your contract. 


Expense NameCost
Mortality & Expensee Fees1.25%
Admininstrative Fees0.15%
Sub-Account Fees1.00%
Additional Rider Fees.75%
Total Fees/Expenses3.05%


A variable annuity might be good for someone who doesn’t mind taking the extra risk to earn a higher return. Out of all annuity types, a variable annuity has the highest potential earning power, even if there could be investment swings along the way. There is an added cost for the annuity insurance expense (and typically higher than average investment expenses) and you might be better off just investing your money in the market directly and getting the assistance of a competent advisor with reasonable advisory fees. That said, there are “stripped down”, low-cost annuities that can serve as prudent tax-deferral/savings vehicles. The devil is in the details.

Gregg Brant, CFP®, APMA®, MBA

Family Wealth Advisor | Contributor

Gregg is a financial planner who is passionate about helping first responders and their families navigate their financial lives with confidence. Having a spouse who is a professor in the State University System, Gregg has worked with the Florida Retirement System first-hand for his own personal financial planning.

Now Gregg is on a mission to take this knowledge and disseminate it to the people who deserve it most; our first responders.