Variable Annuities [Top Pros and Cons]

January 12, 2018
Written by: Steven Gibbs | Last Updated on: April 4, 2023
Fact Checked by Jason Herring and Barry Brooksby (licensed insurance experts)

Insurance and Estates, a strategic life insurance provider composed of life insurance professionals, is committed to integrity in our editorial standards and transparency in how we receive compensation from our insurance partners.

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In the world of annuities, there are a few different types of contracts which vary based upon how the cash value is accumulated on a tax deferred basis.

On one end of the spectrum is the fixed index annuity which offers a conservative contractual rate of return applied to the account or cash value growth.

On the opposite end are variable annuities which carry more risk of investment loss AND also may offer the opportunity for higher returns and cash value growth.

Before we dive into the pros and cons, you deserve an overview of the variable annuity. Top pros and cons will follow.

What is a Variable Annuity?

As a bit of background, an annuity is a contract in the same way that a permanent life insurance policy is a contract. Whereas, a life insurance contract is an asset  that is designed (at least traditionally) to provide a death benefit to one’s estate, an annuity is centered around converting a lump sum payment (or series of payments) into a stream of income for a fixed period (usually for life).

All annuities are for this simple purpose, so the differences between annuity types present themselves in three important ways.

First, annuities may either be immediate annuities OR deferred annuities, which depends on the Annuity Start Date (ASD) and when the lump sum is converted to a regular stream of income.

Second, if an annuity is part of funding a qualified retirement plan, it may be deemed a qualified annuity contract offering certain tax advantages.

Third, an annuity contract will vary in the same way as cash value accumulation with life insurance.

Thus, in the same way that life insurance companies offer alternatives such as guaranteed universal life insurance, indexed universal life insurance OR variable life insurance, annuity contracts offer similar options. And as with life insurance, the riskiest end of the spectrum (in terms of loss potential) is the variable contract, now to be discussed concerning annuities.

Key Distinctions [Variable Annuities vs. Other Types] 

Variable annuities were introduced in the 1950’s as an alternative to fixed index annuities which offer a guaranteed contractual rate of interest in terms of the cash value growth of the account, similar to dividend paying whole life insurance.

Whereas a fixed annuity relies upon the insurance company’s general account to support the contract, a variable contract involves investments in any number of  sub-accounts (potentially dozens) consisting of various classes of assets such as stocks, bonds and money market accounts.

In this way, a variable annuity is similar to a mutual fund but with some added pros and cons to be discussed.

All annuities offer tax deferred growth of cash value, similar to the tax advantages of life insurance, but with few more restrictions.

For example, both qualified annuities and non-qualified annuities restrict the ability to make withdrawals from cash value until age 59 1/2.

So, the difference with variable annuities concerns the account, or actually a second account that is created for selected investments.

The key difference with variable annuities (vs. other types) is that the sub accounts offer the opportunity for a higher rate of return if asset values increase. Some consider this a way to outpace inflation.

However, the annuity owner also bears the risk of the sub-account. If investments decrease in value, the income stream offered by the annuity may also decrease.

In addition, variable annuities typically offer a permanent minimum death benefit for beneficiaries which may be limited to the amount of the initial investment in the annuity contract, and this perhaps offsets some of the sub-account risk.

Pros and Cons of Variable Annuities

With the above distinctions in mind, there are a number of pros and cons of variable annuities to consider as follows:


  1. Guaranteed Stream of Income
  2. Tax Deferred Growth 
  3. Opportunity to Participate in Market Returns
  4. Guaranteed Death Benefit


  1. Early Withdrawal Penalties and Surrender Charges
  2. Risk of Market Losses
  3. Cost of Contract

Annuity Pro [Guaranteed Income Stream] 

A variable annuity, like ALL other annuities, offer a guaranteed payment of income for the life of the annuitant (who may be different from the contract owner). This PRO coincides with the purpose of all annuities, which is for the purpose of protecting against outliving other assets.

For variable annuities, this essential benefit may not be as secure as other types (fixed or indexed annuities) because the income stream may be reduced due to investment sub-account market losses.

Annuity PRO [Tax Deferred Growth]

It is important to understand the difference between tax deferred and tax free when considering this pro which applies to ALL annuities.

Tax deferred growth allows the annuity account to continue to grow without paying taxes on the growth until the time of distributions, withdrawals or surrender of the account.

Theoretically, this allows for additional cash value growth because nothing is being removed from the account to pay taxes. So money that would have been required elsewhere for taxes can be used to fund up the annuity contract. This benefit is similar to what is allowed for the cash value growth of a life insurance contract.

Tax deferred growth does NOT mean that premiums are deductible by an individual or employer. Deducting annuity premiums is only available as part of a qualified annuity which is used to fund a qualified retirement account.

Annuity PRO and CON [Market Returns and Related Risk]

This PRO and related CON is self evident and simply concerns the volatility of the financial markets when compared to a contractual fixed rate of return. This consideration often involves a discussion, on our site, of the importance of a safe bucket investment as coined by Robert Kiyosaki and also relates to topics such as the infinite banking concept AND wealth building with life insurance.

The important take away is that diversity of investments is arguably important and may include stocks, real estate, permanent life insurance and annuities of various types.

Variable investments with either life insurance OR an annuity may have its place as a hedge against inflation AS DOES a safe bucket investment as a hedge against inevitable economic downturns and part of a solid asset protection plan.

Variable Annuity PRO [Guaranteed Death Benefit]

Perhaps the greatest PRO of a variable annuity as opposed to another market based investment (i.e. mutual fund) is the guaranteed death benefit.

This is a way to secure the original account value (original investment) as part of a complete estate plan.

The death benefit is important when it comes to any number of concerns such as estate tax planning, business continuity succession planning or family business succession.

However, it is very important to remember that, unlike their life insurance counterpart, annuities do NOT get a step up in basis of the account value at death and also may result in income taxes (in respect to the decedent) for the estate.

It is also important to remember that other types of non-variable annuities may or may not include a death benefit.

Annuity CON [Early Withdrawal Penalties and Surrender Charges]

A key drawback to ALL annuities, and for variable annuities as a drawback when compared to other investments such as mutual funds, is a lack of liquidity due to early withdrawal penalties and surrender charges.

Annuity Surrender Charges

There are typically 2 PHASES to ANNUITIES which are:


During the accumulation phase, there is a surrender charge period which is usually around 7 years (but can last as long as 15 years), and during this time there are penalties for early withdrawal which are in addition to any tax ramifications for early withdrawals. The surrender charge is used to cover the insurance company’s cost of holding the contract in force.

Annuity Tax Penalties [Early Withdrawal]

In addition, there are tax penalties for withdrawing or surrendering annuity proceeds prior to age 59 1/2. Tax ramifications for early withdrawal include a 10% penalty plus withdrawals being taxed first as income (rather than return of capital) under the “last in first out” (LIFO) method.

Annuity CON [Cost of Annuity Contract]

The fees and expenses on a variable annuity contract can be quite steep when compared to other types of market based investments (and even other annuity types).

For example, an average fee for a variable annuity contract can be between 2% and 2 1/2% but it isn’t unusual to see fees in the 4% ranges.

Other investments such as mutual funds typically charge within a range of .25% to 1.5%. The reality behind this is there is a fee to secure the guarantees offered by the contract.

As with ALL wealth building and preservation strategies, we suggest a thorough and careful review and expert guidance before making a critical decision. For more information, connect with us today.



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