The Disadvantages of Variable Annuities

Fees, taxes and possible forfeitures are among the disadvantages of a variable annuity.

Jupiterimages/ Images

Variable annuities offer tax-deferred retirement savings over an extended period. You fund your account by making one or more deposits. Unlike a fixed annuity, a variable annuity may purchase stocks and mutual funds with your deposits. This increases the possible yield for the annuity, but it also increases your risk. There can be disadvantages to using a variable annuity to save for your retirement, just as there are potential disadvantages to any investment vehicle. So consider your options carefully before opening an account.


Variable annuities charge several types of fees, which reduces your overall yield. Make sure to include these fees when comparing annuities with other investment options. If you withdraw money before the end of your annuity's waiting period, you pay a surrender charge. You also pay an annual administration fee, plus any investment fees charged by the mutual funds in your account. Mortality and expense fees will apply if your policy provides a death benefit.

Taxes and Penalties

Your money will be taxed as ordinary income, not as capital gains, when you withdraw it. There might be a significant increase in taxes due if you start taking withdrawals before your income drops in retirement. If there is a big enough difference between your ordinary income tax rate and the capital gains tax rate, you could lose all of the benefits of using a tax-deferred annuity to save for retirement. If you are not at least 59 1/2 when you begin taking money out of the annuity, you will be charged a 10 percent early-withdrawal penalty on any gains on your investments.

Risk of Loss

Your investments could fluctuate in value, leaving you with less money than you put into the annuity. You might be able to mitigate these losses by purchasing a rider for your policy. Some annuity companies offer riders that lock in your gains after a certain date, or that guarantee minimum payments regardless of your portfolio's performance. These riders typically incur a fee to compensate the annuity company for its additional risk.


If you annuitize your account -- that is, request regular payments from it, based on your life expectancy -- and die before you receive all of your deposited funds, you could forfeit the account balance to the annuity company. You might be able to add death benefits to your policy so that any investment balance would be transferred to your heirs. But, after you have annuitized, this typically is limited to the amount of your deposits and does not include any interest or any increases in investment value. Some plans allow a designated beneficiary to continue receiving your periodic annuity payments throughout their lifetime -- a benefit that will add to your costs. You also might have the option of withdrawing your initial deposit when you reach retirement age, rather than annuitizing it, to reduce the risk that you will lose money when you die.