The Disadvantages of a Tax-Deferred Variable Annuity

by Chris Joseph

If you own a life insurance policy, your agent may approach you about purchasing a tax-deferred variable annuity at some point. Variable annuities are retirement investment products sold by insurance companies. You typically fund the annuity over time by making regular premium payments. While variable annuities could provide a significant return on your investment in the long run, they also come with some possible disadvantages for you to consider.


With a variable annuity, a portion of your premium covers costs, fees and commissions, while the rest is placed in a fund that invests in securities such as stocks, bonds and money market vehicles, often in the form of mutual funds. Your earnings grow on a tax-deferred basis, meaning you do not owe taxes until your begin to make withdrawals. At a certain point, the product "annuitizes," and you can begin to receive regular payouts, which can last for the rest of your life if you choose, or receive the money in one lump sum. If you die, your designated beneficiary can begin to receive the annuity proceeds.

No Guarantee

Although tax-deferred variable annuities could provide a high return if your investments perform well over time, there is no guarantee that you will make money. If securities under-perform for an extended period, you could see little or no return on your money at all. With some types of variable annuities, you could even lose a portion of the amount you contribute.

High Costs

Because of the need for the professional management of the associated investment account, variable annuities come with high management fees, which can range from 1 to 4 percent of your account balance, according to If you make withdrawals before the maturity date, the insurance company will likely levy a charge in the range of 5 to 15 percent of the withdrawn amount. If the withdrawal occurs prior to age 59 1/2, federal law requires the assessment of a 10-percent penalty in most cases, and the amount of your withdrawal is considered as taxable income for the year in which you receive the money.


When compared to investing directly in the stock market, variable annuities offer one specific tax disadvantage. Gains on stocks are considered capital gains, which are taxed at a lower rate than ordinary income. When it comes time to begin withdrawing the money from your variable annuity, the gains are taxed at the higher ordinary income rate.

No Upfront Tax Benefits

While variable annuities can provide similar returns and tax-deferral benefits as other retirement vehicles such as your 401k plan at work or a traditional IRA that is invested in securities, they do not offer an upfront tax-deduction benefit that these products can provide. If you're investing in a variable annuity while neglecting these products, you could be paying more in taxes than is necessary.

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