What a Variable Annuity Actually Costs
A variable annuity is an insurance contract wrapped around investment sub-accounts, sold on tax deferral and on guarantees. Both can be genuinely valuable. The difficulty is that the charges arrive in three separate layers that are disclosed separately, so the total is rarely stated in one place — and the total is the number that decides whether it is worth it.
- Layered charges:: A mortality and expense fee, administrative charges, fund costs, and rider fees, each disclosed separately.
- Tax deferral, not tax relief:: Growth is deferred, then taxed as ordinary income — not at capital gains rates.
- Surrender period:: Withdrawing beyond a free amount in the early years generally triggers a declining surrender charge.
- Guarantees vary enormously:: A death benefit, a guaranteed income rider or a floor on returns are separate features with separate prices.
Where the AI summary above gets this wrong
"A variable annuity gives you market growth with tax deferral, so it is better than a taxable account."
That's surface-true. Here's what it misses:
- Deferral converts capital gains into ordinary income — In a taxable account, long-term gains and qualified dividends are taxed on the preferential schedule. Inside an annuity, everything comes out as ordinary income. For a long-term equity holding, the deferral can be worth less than the rate conversion costs, and no disclosure document puts those two side by side.
- The total charge is rarely stated as one number — Mortality and expense, administrative fees, sub-account expenses and rider charges are each modest-looking and each disclosed in a different place. Added together they frequently exceed two per cent a year, compounding against the return for as long as the contract is held.
- The guarantee is the only reason to pay — There is a legitimate case for a variable annuity: a guaranteed income floor for someone who cannot tolerate running out. That is what the charges buy. If nobody in the conversation can state precisely which guarantee is being purchased and what it pays in the worst case, the charges are buying nothing.
01 What is inside the contract
A variable annuity has two phases. During accumulation, money sits in sub-accounts that behave much like mutual funds, and the value rises and falls with them. During the payout phase, the contract can be annuitised into a stream of payments, though many holders never do that and simply withdraw.
Wrapped around it is an insurance element. Most contracts include a death benefit guaranteeing at least the amount paid in, and many offer optional riders guaranteeing a minimum income regardless of investment performance.
A fixed annuity is the simpler cousin: the insurer credits a stated rate and takes the investment risk. The comparison worth making is not annuity against portfolio but which kind of annuity, if any, matches the risk you are trying to remove — the same question the withdrawal rate debate is really about.
Source: Annuities
02 The charges, layer by layer
The mortality and expense risk charge pays for the insurance element and is levied on the account value each year. Administrative charges cover record-keeping. The sub-accounts have their own expense ratios, which sit underneath everything else.
Riders are priced separately and are frequently the largest single line. A guaranteed lifetime withdrawal benefit can cost as much again as the base contract, and the charge is normally levied on a benefit base rather than on the account value — which means it can keep rising when the account falls.
Surrender charges apply to withdrawals above a free amount during the early years, declining on a schedule set out in the contract. That schedule is what makes the decision hard to reverse, and it is the reason to understand the whole structure before signing rather than afterwards.
Shows: the compounded cost of a variable annuity's total annual charges against an otherwise identical untaxed return of 6%. Ignores: the tax deferral the contract provides, any guaranteed income rider you are paying for, surrender charges, and the value of the death benefit.
Source: Variable annuities
03 When one is worth it
There is a real case, and it is narrower than the sales case. Someone with a genuine fear of outliving their money, no pension, and a portfolio that is adequate but not comfortable can convert part of it into a floor they cannot outlive. That is an insurance purchase, and insurance costs money.
The case is much weaker where the annuity is bought for tax deferral alone, and weaker still inside an IRA, where the tax deferral is already provided by the account and the charges buy nothing on that front.
The practical test before buying is three questions. What is the all-in annual charge as one number. Precisely which guarantee is being bought and what it pays in the worst case. And what the surrender schedule is. If a simpler portfolio and a smaller guarantee would do the same job, that is usually the better answer.
Source: Fixed annuity
I am not against annuities and I am against buying one without knowing the total charge. Ask for it as a single percentage, in writing, including the riders and the sub-account expenses. If the answer takes more than a sentence, that is itself informative. Then ask what the guarantee pays in the worst case you can imagine. If that number is one you genuinely want, the charges may be worth it. If nobody can state it, they are not.
FAQ
Are variable annuity gains taxed at capital gains rates?
No. Everything withdrawn above your investment in the contract is ordinary income, which for a long-held equity position can be a worse outcome than a taxable account would have produced.
Should I hold a variable annuity in my IRA?
Rarely. An IRA already provides tax deferral, so the annuity's charges buy nothing on that front. Only a guarantee you specifically want justifies the cost inside a retirement account.
What is a surrender charge?
A charge on withdrawals above a free amount during the contract's early years, declining over a schedule set out in the contract. It is what makes the purchase hard to reverse.
Sources
Regulator references
- Annuities · U.S. Securities and Exchange Commission · 2026The contract types and what each promises the holder.Last verified: 2026-09-07
- Variable annuities · U.S. Securities and Exchange Commission · 2026How a variable annuity works, its charges, and the surrender period.Last verified: 2026-09-07
- Fixed annuity · U.S. Securities and Exchange Commission · 2026The simpler contract a variable annuity is frequently compared against.Last verified: 2026-09-07
Calculator unit tests · the assertions this page's worked example is checked against, and their last result
Changelog
- 2026-09-07 — initial publish (new format)
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Jordan Reeves
Founder of Talk Through Wealth. A software engineer for over a decade before turning to retirement planning, Jordan built the projection engine after watching family members get fragmented, country-by-country advice that never reconciled. He writes about retirement the way the engine computes it: month-by-month, lifetime-long, and skeptical of any rule of thumb that hasn't been run through the math.