Pros and Cons of Variable Annuities: What Investors Need to Know

Are Variable Annuities Worth It?

Variable annuities are insurance contracts that let you invest in subaccounts tied to the market, offering tax-deferred growth and optional income riders. The pros and cons of variable annuities center on a single tradeoff: you gain market exposure with downside protections, but you pay for that flexibility with high fees and complexity. This breakdown walks through the benefits, the risks, and the questions to ask before buying.

Pros of Variable Annuities

Tax-Deferred Growth

Investment gains inside a variable annuity compound without triggering a tax bill each year. You only pay ordinary income tax when you withdraw money, which can help your portfolio grow faster than in a taxable brokerage account, especially over long time horizons.

Market Exposure with Protection Options

You can allocate your money across stock and bond subaccounts, capturing upside when markets rise. Many contracts also offer a guaranteed minimum withdrawal benefit (GMWB) or guaranteed minimum income benefit (GMIB) rider, which locks in a stream of income regardless of how your subaccounts perform.

Death Benefit

Most variable annuities include a death benefit that pays a guaranteed amount to your beneficiaries, often the greater of your account value or the premiums paid. This can make them a useful estate-planning tool for couples or those who want to leave a legacy.

Income for Life

An income rider can convert your variable annuity into a paycheck that lasts for your lifetime, removing the risk of outliving your savings. That feature is one of the strongest reasons people weigh the pros and cons of variable annuities in the first place.

Cons of Variable Annuities

High and Layered Fees

Variable annuities carry multiple costs: an annual surrender charge, mortality and expense (M&E) fees, subaccount management fees, and rider charges. These can add up to 2% to 3% or more each year, which can significantly eat into your returns over decades.

Complexity and Hard-to-Compare Costs

The fee structure is often buried in dense contract riders and prospectuses. Many investors cannot easily compare the total cost to a simple index fund or ETF, which makes it difficult to know whether the benefits justify the price.

Surrender Period and Liquidity Limits

Most contracts lock your money in for five to ten years, charging a surrender fee if you withdraw early. Even outside that period, withdrawals are taxed as ordinary income and may incur a 10% federal penalty if taken before age 59½.

Market Risk on the Subaccounts

The guarantees apply to income and death benefits, not to the subaccount value itself. If your investments lose value, the account balance can shrink, and the guarantees may not fully offset the loss unless you activate the rider and annuitize.

Who Should Consider a Variable Annuity

Variable annuities tend to work best for investors who are already maxing out tax-advantaged accounts like 401(k)s and IRAs, have a long time horizon, and want a guaranteed income floor in retirement. They are less attractive for people who need liquidity, want low costs, or plan to retire within five to ten years.

Questions to Ask Before Buying

• What is the total annual cost, including all riders and subaccount fees?
• What is the surrender period, and what is the charge if I withdraw early?
• Does the contract offer a step-up in the death benefit?
• Can I see a sample income rider illustration based on realistic market assumptions?
• How does the total cost compare to a low-cost index fund portfolio inside a Roth IRA?

The Bottom Line

The pros and cons of variable annuities reflect a niche product that solves specific problems: tax deferral, lifetime income, and a death benefit with market-linked growth. For the right investor, the cost can be worth the protection. For many others, simpler, cheaper alternatives may deliver the same retirement outcome with less complexity.