Sound Advice: September 16, 2026

Why buy variable annuities when you can buy mutual funds, which are similar investments with lower fees?

If the underlying investments are essentially the same mutual funds, a variable annuity often adds a layer of cost and complexity without improving the investment itself.

The key distinction is that a variable annuity is not primarily a better investment vehicle. It's an insurance contract wrapped around investments.

Why choose the variable annuity?

There are a few legitimate reasons:

1. Tax deferral
   Gains inside the annuity aren't taxed each year. But this benefit is much less compelling if you're already using a tax-advantaged retirement account such as an IRA or 401(k).
2. Death benefit
   Some contracts provide a guaranteed minimum death benefit. This can be valuable in particular circumstances, although you're paying for it.
3. Guaranteed-income riders
   Some variable annuities offer living-benefit riders that can provide a contractual income guarantee. Again, that's an insurance feature—not an investment advantage.
4. Behavioral discipline
   An annuity can make it psychologically harder to sell investments during a market downturn. That's real, but it's an expensive way to solve a behavioral problem.

The problem is the cost.

Imagine two portfolios holding essentially identical underlying investments:

	Mutual funds	Variable annuity
Investment expenses	Low	Often higher
Contract/insurance expenses	None	Yes
Optional rider fees	None	Often additional
Tax deferral	No*	Yes
Liquidity	High	Often restricted
Surrender charges	Usually none	Often
Investment choices	Broad	Contract-dependent
Death benefit	No	Possibly
Guaranteed income	No	Possibly

*Assuming a taxable account; mutual funds inside an IRA/401(k) are already tax-deferred.

And the difference in expenses compounds.

For example, suppose you invest $500,000 for 25 years and earn 7% before expenses:

• At 0.20% annual expenses: roughly $2.66 million
• At 1.50% annual expenses: roughly $1.98 million

That's a difference of about $680,000.

And that is why you should be particularly skeptical of the argument:

"But the annuity gives you tax deferral."

Tax deferral is valuable, but it isn't free. If you're paying substantially higher annual expenses for decades to obtain it, the tax benefit can be overwhelmed by the additional costs.

There's another important issue: ordinary-income taxation

With a typical nonqualified variable annuity, withdrawals of earnings are generally taxed as ordinary income, rather than potentially receiving the preferential long-term capital-gains treatment available for many investments held outside an annuity.

And unlike stocks or mutual funds held in a taxable account, an annuity generally doesn't receive a step-up in basis at death.

So when should someone consider one?

Consider a variable annuity primarily when the buyer specifically needs an insurance guarantee—for example, a valuable lifetime-income guarantee that cannot easily be replicated with a conventional investment portfolio.

Do not buy one merely because:

• it contains mutual funds,
• the salesperson says "tax deferred,"
• it offers a death benefit that you don't need,
• or the salesperson says it will "protect" you from the market.

If you want investment exposure, buy investments. If you need insurance, buy insurance. Combining the two can make sense—but you should have a very specific reason for paying for the combination.