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Sound Advice: August 19, 2026

Here’s Why You Shouldn’t Buy a Variable Annuity?

A variable annuity isn't inherently a bad product. In the right situation—typically someone who has already maxed out other tax-advantaged accounts, wants tax-deferred growth, and values guaranteed lifetime income—it can make sense.

Still, many financial advisors argue that most people pay more than they receive in benefits. Here are the biggest reasons.

1. High fees eat away at returns

Variable annuities often layer multiple fees:

  • Mortality and expense charges: 1.0%–1.5%
  • Investment management fees: 0.5%–1.5%
  • Rider fees (income or death benefits): 0.5%–1.5%
  • Administrative fees

It's not unusual for the total annual cost to exceed 2%–3%, which can substantially reduce long-term growth compared with low-cost index funds.

2. Investment gains are taxed as ordinary income

Unlike stocks held in a taxable brokerage account, where long-term gains receive preferential capital gains tax treatment, earnings withdrawn from a variable annuity are generally taxed as ordinary income, which may be a higher rate.

3. Surrender charges limit flexibility

Many contracts impose surrender periods lasting 5 to 10 years or longer. If you need your money early, you could pay significant penalties.

4. Complex contracts

Variable annuities can be hundreds of pages long and include:

  • Income riders
  • Death benefits
  • Withdrawal restrictions
  • Investment limitations
  • Guaranteed withdrawal formulas

Many buyers don't fully understand how these features work—or what they cost.

5. Better alternatives often exist

Before buying a variable annuity, many people would benefit more from:

  • Maxing out a 401(k)
  • Contributing to an IRA or Roth IRA (if eligible)
  • Investing in low-cost index funds
  • Considering ETFs with very low expense ratios

These options often provide lower costs and greater flexibility.

6. Sales commissions can create conflicts

Many variable annuities pay commissions of 4%–8% or more to the selling representative. Although that doesn't automatically make the recommendation inappropriate, it can create an incentive to recommend an annuity over lower-cost investments that pay little or no commission.

7. Guarantees are not free

Income guarantees and principal protection are funded by the fees you pay and are backed by the financial strength of the issuing insurance company. If you don't actually need those guarantees, you may be paying for benefits you'll never use.

When a variable annuity can make sense

They may be worth considering if you:

  • Have already maxed out all other retirement accounts.
  • Want guaranteed lifetime income in retirement.
  • Expect to be in a lower tax bracket later.
  • Value insurance features more than maximizing investment returns.
  • Plan to hold the contract for many years.

Bottom line

For many investors, a simple portfolio of diversified, low-cost index funds held in retirement accounts and taxable brokerage accounts can provide higher expected after-fee returns with greater flexibility.

Variable annuities are most compelling when the insurance guarantee itself—such as lifetime income—is the primary objective. If your goal is simply investment growth, the higher costs and tax treatment often make them less attractive than other options.

 

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