Variable Annuities: Benefits, Risks, and Who Should Consider One

Introduction

Every retirement investment comes with trade-offs. Some prioritize safety, while others focus on long-term growth. Variable annuities fall into the second category, offering investors the opportunity to participate in the financial markets while still providing retirement-focused benefits such as tax-deferred growth and optional lifetime income.

Unlike fixed annuities that guarantee a set interest rate, variable annuities allow your money to grow—or decline—based on the performance of professionally managed investment portfolios. This higher growth potential makes them attractive to investors who have time to weather market fluctuations.

However, greater opportunity often comes with greater risk. Variable annuities can involve investment losses, fees, and contract complexity that aren’t found in some other retirement products.

In this guide, we’ll examine the key benefits and potential drawbacks of variable annuities, helping you decide whether this type of annuity belongs in your retirement plan.

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What Makes a Variable Annuity Different?

A variable annuity differs from other annuity types because your returns are tied to investment performance rather than a guaranteed interest rate.

Instead of earning a fixed return, your money is invested in subaccounts that may include:

• Stock portfolios
• Bond portfolios
• Balanced investment portfolios
• International funds
• Money market investments

As these investments gain or lose value, so does your annuity account.

This gives investors more growth potential than fixed annuities but also introduces market risk.

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Major Benefits of Variable Annuities

Variable annuities offer several features that appeal to long-term retirement investors.

1. Greater Growth Potential

One of the biggest advantages is the opportunity for higher returns.

Because your investments participate in the financial markets, your account has the potential to grow faster than products with guaranteed fixed interest rates.

Although returns are never guaranteed, investors with long time horizons may benefit from long-term market growth.

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2. Tax-Deferred Growth

Like most annuities, variable annuities allow investment earnings to grow tax-deferred.

Instead of paying taxes every year on gains, taxes are generally postponed until withdrawals begin.

This allows investment earnings to compound over time, potentially increasing retirement savings.

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3. Lifetime Income Options

Many variable annuities allow you to convert your account into guaranteed income payments during retirement.

Depending on the contract, income can continue:

• For your lifetime
• For both you and your spouse
• For a specified period

Some contracts also offer guaranteed lifetime withdrawal benefits through optional riders.

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4. Investment Flexibility

Variable annuities often provide dozens of professionally managed investment options.

This flexibility allows investors to:

• Adjust risk levels over time.
• Diversify across asset classes.
• Rebalance investments.
• Match portfolios with retirement objectives.

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5. Death Benefit Protection

Many contracts include death benefit provisions that help protect beneficiaries.

If the owner dies before receiving all retirement benefits, designated beneficiaries may receive remaining account value or another benefit specified in the contract.

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Potential Risks of Variable Annuities

While variable annuities provide meaningful advantages, they also carry important risks.

Market Volatility

Because investments are linked to financial markets, account values fluctuate daily.

Periods of market decline can significantly reduce retirement savings, especially if they occur shortly before retirement.

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Investment Losses

Unlike fixed annuities, variable annuities generally do not guarantee principal protection.

Investors must be comfortable with the possibility of temporary—or even extended—market losses.

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Higher Fees

Variable annuities often include more expenses than other annuity types.

Possible fees include:

• Mortality and expense charges
• Administrative fees
• Investment management fees
• Rider costs
• Surrender charges

These expenses can affect long-term investment performance, making it important to compare products carefully.

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Contract Complexity

Variable annuity contracts may contain detailed provisions regarding investments, riders, guarantees, withdrawal rules, and fees.

Reading and understanding the contract before purchasing is essential.

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Who May Benefit from a Variable Annuity?

Variable annuities are often best suited for individuals who:

• Have a long investment horizon.
• Are comfortable with market fluctuations.
• Want higher growth potential.
• Have already built an emergency savings fund.
• Seek tax-deferred investing.
• Want the option of guaranteed retirement income later.

These characteristics often make variable annuities attractive to investors who are several years away from retirement.

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Who May Want to Consider Other Options?

Variable annuities may not be ideal for everyone.

You may prefer another retirement product if you:

• Want guaranteed principal protection.
• Need immediate access to your savings.
• Are uncomfortable with stock market volatility.
• Prefer simpler financial products.
• Are seeking the lowest possible investment costs.

For these investors, fixed or indexed annuities may provide a better balance of risk and stability.

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Comparing Variable Annuities with Other Annuity Types

Each annuity type serves a different purpose depending on an investor’s financial objectives and risk tolerance.

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Questions to Ask Before Buying

Before purchasing a variable annuity, ask yourself:

• Am I comfortable with investment risk?
• How much market volatility can I tolerate?
• How long do I plan to keep this investment?
• Do I understand all contract fees?
• Which optional riders do I actually need?
• Does this annuity fit within my overall retirement strategy?

Answering these questions can help ensure the product aligns with your financial goals.

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Frequently Asked Questions

Are variable annuities risky?

Yes. Variable annuities involve market risk because investment performance directly affects account value.

Can a variable annuity outperform a fixed annuity?

It can, especially during strong market conditions. However, higher returns are never guaranteed, and losses are possible.

Why are fees higher?

Variable annuities often include investment management, insurance guarantees, and optional rider benefits, all of which can increase costs.

Can I switch investments?

Many contracts allow transfers among available investment options, although rules and limitations vary by insurer.

Is a variable annuity suitable for retirement?

It may be appropriate for investors seeking long-term growth with the option of future retirement income, provided they understand the associated risks and costs.

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Key Takeaways

• Variable annuities offer the potential for higher long-term growth through market-based investments.
• Tax-deferred growth and optional lifetime income features are major advantages.
• Market risk, investment losses, and higher fees are important considerations.
• Variable annuities are generally best suited for long-term investors who are comfortable with market fluctuations.
• Carefully reviewing contract terms and comparing products can help you choose an annuity that aligns with your retirement goals.

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Conclusion

Variable annuities provide a unique combination of investment opportunity and retirement income planning. They can help investors pursue higher long-term returns while offering valuable insurance features such as tax-deferred growth and optional lifetime income guarantees.

However, these benefits come with trade-offs, including market risk, contract complexity, and potentially higher fees. Before investing, take the time to understand how the product works, evaluate your risk tolerance, and consider how a variable annuity fits into your broader retirement strategy.

When chosen thoughtfully and used as part of a diversified financial plan, a variable annuity can become a valuable tool for building retirement income and pursuing long-term financial security.