This article is part of the Retirement Financial Life Equation (RFLE) series. It was initially published on June 23, 2021, and updated in January 2026.
This is a follow-up to my previous article on the role that immediate income annuities can play in providing additional income for individuals nearing retirement income limits. The focus was on Single Premium Immediate Annuities (SPIAs), a type of fixed income annuity.
But there are two other types of annuities: indexed and variable. The main difference between fixed annuities and the indexed and variable varieties is that fixed annuities pay a fixed amount each period. In contrast, your income from indexed and variable annuities is tied to the stock market’s performance in one way or another.
Note: For a comprehensive examination of these products, see my three-part series: Immediate Fixed Annuities (Part 1), Fixed Index Annuities (Part 2), and Variable Annuities (Part 3). This article provides a comparative overview with practical guidance for those considering either type.
Indexed and variable annuities are not ordinarily purchased to provide immediate retirement income. Instead, they’re usually sold to those still saving for retirement who want to safeguard their principal in exchange for potentially lower stock-market returns. (As such, they’re used mainly as a de-risking strategy.) Others may use them as longevity annuities, letting them grow for 5, 10, or 15 years into retirement before tapping them for income, helping ensure they don’t run out of money later. On that basis, they’re used as a mitigation strategy for market and longevity risk.
Still, you may be interested in one, or be offered a proposal for one, at any time before or during retirement, and the sales pitch can sound quite appealing. Therefore, you would do well to have a general understanding of what they are, how they work, and what to look for in the “fine print” should you decide to purchase one.
Not your father’s annuity
These products are more sophisticated than plain vanilla immediate income annuities. In fact, they have existed only since the 1990s, whereas income annuities date back to ancient Egypt and Rome.
An indexed annuity (also called a Fixed Index Annuity, or FIA) is a hybrid product that combines features of fixed and variable annuities. It typically has a “base” return similar to a fixed annuity, but its value is tied to the performance of a specified stock index, such as the S&P 500. If the index rises, your returns may increase, though not as much as the index does when the market is up significantly in any given year.
2025 update: FIA cap rates have improved significantly. Current top-tier products offer caps of 10-11% (compared to 5-6% in the 2010s), making them more attractive than they were a few years ago. For detailed analysis, see Part 2 of my annuities series.
Variable annuities are linked to an underlying asset account, typically containing mutual funds, rather than to a market index. You have some freedom in selecting the investments that you hold in that account relative to how much risk you want to take, but your options in each risk category may be limited. The overall performance of your annuity is tied to the performance of those assets, typically stock mutual funds.
2025 update: Variable annuity fees remain high (averaging 2.0-3.0% base, 3.0-4.5% with riders), though some low-cost options have emerged. See Part 3 of my annuities series for a complete cost analysis.
All of these products are government-regulated. Federal laws put equity-indexed annuities under state insurance regulation, but variable annuities are subject to state insurance regulation and federal securities regulation.
Deferred vs. immediate annuities
Annuities can also be either deferred or immediate. This pertains to the point at which you begin receiving annuity payments as income.
Deferred annuities are typically indexed or variable annuities, but can also be income annuities. Because you leave your principal and any earnings alone, they accumulate more assets and grow in value over time. Exactly how they succeed depends on how you invest your principal—stocks, bonds, or guaranteed interest. Withdrawals are made as a lump sum or as regular income payments, typically in retirement.
Immediate annuities allow purchasers to convert a lump-sum payment into a stream of income that begins immediately (as with SPIAs mentioned earlier). Nevertheless, they can be initially purchased as a deferred annuity and later converted to an immediate annuity. The income is “guaranteed” by the insurance company for a specified period, or for a single person’s life, or the life of that person and a survivor. Income tends to be highest for period-certain policies, then for a single person’s lifetime, and lowest for a single person’s lifetime and a survivor’s.
2025 update: Immediate annuity payout rates have improved dramatically. A 73-year-old can now receive approximately 8.1% annual payout rates (compared to 5.8% in 2019), the best environment for immediate annuities in over a decade. See Part 1 of my series for current rates and analysis.
As you might imagine, given the number of types and variants, navigating the world of annuities can be a daunting task. That’s one reason I lean toward SPIAs for those who would benefit from an annuity as a source of retirement income. Their relative simplicity makes them easy to understand and integrate into an overall retirement plan.
They’re attractive
The most attractive feature of indexed and variable annuities is that, unlike SPIAs, they generally offer upside potential while limiting downside risk, often with a guaranteed income stream (which may incur an additional cost—a “rider” fee).
SPIAs pay a fixed income unless you purchase one with scheduled payment increases of a certain percentage each year, which results in lower initial payouts, but they will grow over time. Unfortunately, inflation-adjusted SPIAs are extremely rare in the marketplace—only Principal Life offers true CPI-linked immediate annuities as of 2025.
Because of their possible upside and limited downside, indexed and variable annuities can be very attractive. I’m not saying no one should ever purchase one. There are undoubtedly some decent products in the marketplace, but I want to emphasize that they’re not suitable for everyone and come with significant complexity and cost.
Their complexity makes variable annuities hard to understand and compare. And their cost makes them, well, costly, at least compared to other options.
But you may be surprised to learn that annuities outsell all other life/health insurance products. According to the Insurance Information Institute, “Measured by premiums written, annuities are the largest life/health product line, followed by life insurance and health insurance.”
2025 update: FIA sales reached $125.5 billion, with 96 new products released (a 35% increase over 2024). FIAs now outsell variable annuities, reflecting investor preference for principal protection with market participation.
In other words, insurance companies sell a lot of them and make a ton of money from them!
Market volatility drives sales
What can make indexed and variable annuities even more attractive is equity and credit market turmoil. It’s no secret that this creates concern—and sometimes angst and panic (during a market crash)—among investors, which can lead to emotionally driven investment decisions, rushing to purchase products they don’t fully understand, and overlooking prudently considered alternatives. Such actions can have undesirable long-term consequences.
Have you noticed that the marketing of these products by insurance companies on TV, online, and in print media increases during times of market volatility? The insurance industry thrives during times of market volatility and uncertainty. The more market turmoil, the more appealing annuity products become. This is especially true in the wake of significant market declines.
Annuity products are all-in-one solutions with features that befuddle all but the most financially sophisticated. They make claims like “receive guaranteed income while also capturing stock market returns without stock market risk.” Claims like that appear to be too good to be true—and they often are. (And telling only part of the “truth” doesn’t qualify as truth, in my opinion.)
But, “caveat emptor”
I took two years of Latin in high school, but the only phrases I remember are “e pluribus unum,” “novus ordo seclorum,” “carpe diem,” and “caveat emptor” (buyer beware). (Okay, I know a few more, such as “North Carolina est non insula” and “Florida est non insula, Florida est peninsula.” But I digress.)
Why “buyer beware”? On the one hand, indexed and variable annuities are especially popular with investors because they offer guarantees in addition to the potential for growth—a compelling proposition. But they can be challenging to understand and compare, expensive to purchase, and not entirely risk-free.
Do they offer some attractive features? Absolutely, but you want to ensure you need them, understand them, and know what they will cost before signing the agreement.
Need
As discussed in the previous article, some retirees will require additional guaranteed income in retirement; without a pension, an income annuity can meet that need. But purchasing an indexed or variable annuity is more of a want and depends on their risk tolerance relative to their financial goals and the best way to achieve them. Annuities can be a good option to “fill in the gaps” in a retirement income plan that is running short on income from other sources.
Fixed annuities appeal to those with very low risk tolerance who use them to replace fixed-income investments (such as CDs and bonds) in their portfolios. Those willing to tolerate greater risk may favor indexed or variable annuities, which allow them to remain invested in the stock market, either directly or indirectly. They can also add contract riders (for a fee) for features such as higher earnings caps, guaranteed income, or a death benefit.
These products may also be helpful for wealthier individuals with more investable assets who have maxed out their retirement accounts. Indexed and variable annuities are some of the few vehicles that enable tax-deferred growth in non-retirement accounts.
Costs
Costs really matter because they reduce earnings. If you pay 1.5% in fees, your earnings will be reduced by that amount. It’s also problematic that not all annuity costs are readily apparent. Some may be explicitly stated, but others are more obscure and hard to identify. It’s important to know which costs to ask about so you can determine exactly what an annuity product will cost you per year.
Annuity costs fall into two categories: direct and indirect. Direct costs are typically fees, whereas indirect costs include items such as sales commissions. We’ll look at both.
Fixed Index Annuity Fees (2025)
The most common costs for fixed index annuities are for optional features such as an income rider, enhanced death benefits, or higher caps and participation rates.
Current FIA costs:
- Base product: Typically, no explicit annual fees (costs embedded in cap/spread structure)
- Income riders (GLWB): 0.75-1.5% annually
- Enhanced death benefits: 0.25-0.75% annually
- Surrender charges: 9% declining to 0% over 7 years (typical)
- Most allow 10% penalty-free withdrawals annually
Key point: The “cost” of an FIA is primarily in what you give up—no dividends (2-3% historically), capped upside (even with 10-11% caps), and potential for lower long-term returns compared to direct index fund investing.
For a detailed analysis of FIA costs and performance, see Part 2 of my annuities series.
Variable Annuity Fees (2025)
Variable annuities are among the most popular products, though FIAs have recently overtaken them in sales. They are also the most costly, primarily because they’re investment products rather than insurance products.
2021 baseline I cited:
- Variable annuities: $98.6 billion sold in 2020
- Immediate and fixed income annuities combined: $120.5 billion in 2020
Here’s an updated list of the standard fees you’ll pay for a variable annuity:
- Administrative Fees: A relatively minimal service fee for your retirement account. You can expect to pay up to 0.30% of the account value annually, or a flat fee of $30- $100 (often waived for larger accounts).
- Mortality & Expense (M&E) Risk: This covers death benefits and specific guarantees. These fees run from 1.15% to 1.35% per year (average ~1.25%).
- Investment Management Fees: This is an investment advisory fee for choosing and managing your selected assets (typically stock and bond funds) in the underlying sub-account. These can range from 0% to 1.5% of the asset value per year.
- Underlying Investment Fees: The fee charged by the mutual fund managers for the investments selected for the sub-account. These range from 0.60% to 3.0% per year (average ~0.94%), depending on the funds.
- Guaranteed Lifetime Withdrawal Benefit (GLWB): An income rider fee providing guaranteed income payout regardless of sub-account performance. Current rates: 0.30% to 2.5% of the account value per year (average ~1.10%), depending on the policy. Payout rates now range from 3.5% to 6.75%, depending on age and whether the election is single or joint.
- Other Riders or Annuity Expenses: These include optional increased caps and participation rates; enhanced death-benefit riders (0.25-0.51%); long-term care riders (0.40-1.0%); joint life or spousal income riders (0.25-0.75%); or minimum accumulation benefits. Depending on the options you select, this may incur a fee of 0.50%-3.0% or more.
- Annuity Surrender Fees: Variable annuities that pay a large up-front commission almost always have a surrender charge. This charge applies only if you withdraw funds from the policy within a specified period, typically 5 to 10 years. Typical schedule: 7-10% declining to 0%. Some “L-share” products have shorter periods (3-4 years) but may have trade-offs. It won’t be an issue for most retirees who want to keep the annuity throughout retirement.
Total variable annuity costs:
- Base (no riders): 2.0-3.0% annually (average ~2.31%)
- With popular riders: 3.0-4.5% annually
- With multiple riders: Can exceed 4.5% annually
2025 improvement: Some companies now offer low-cost variable annuities. For example, Schwab’s Genesis Variable Annuity has base fees 56-66% below the industry average with no surrender charges—though you still need the underlying investment funds to perform well enough to overcome even these lower fees.
For a comprehensive cost analysis and whether variable annuities make sense, see Part 3 of my annuities series.
Sales commissions
These are not fees per se since, in most cases, you won’t pay them directly from your principal. The insurance company pays them, and occasionally the firms managing the underlying investments in the sub-accounts of a variable annuity. You won’t see it as a debit from your account; the company does it in the background as part of its cost of doing business.
The pressure on stockbrokers and insurance salespeople is enormous because they can make as much as 10% or more in commissions per sale, depending on the annuity type and how many “bells and whistles” you add. The more straightforward the annuity contract is, the lower the commission. That’s why SPIAs pay relatively low commissions compared to their more complicated cousins.
A commission of 7% on a $500,000 variable annuity would pay a tidy $35,000—not a bad payday (although the company may pay it out to the salesperson over a period of years). That’s not “bad” or “wrong”—good salespeople are entitled to compensation when they make a sale—but you need to know this because it may (and I emphasize it may) result in a conflict of interest. In other words, a salesperson may steer you toward a particular product that might be okay for you but would be great for them because it pays a higher commission.
2025 update: Commission-free FIAs and variable annuities are now available through fee-based advisors, though they’re still relatively rare. This can help eliminate the commission conflict of interest if you’re working with a fiduciary advisor.
Income Taxes
Regardless of type and whether they are held in qualified retirement accounts (such as an IRA), annuities grow tax-deferred; however, withdrawals from an IRA are taxed at your income tax rate. IRAs also grow tax-deferred, so there is no tax advantage to owning an annuity inside an IRA.
Annuities do provide tax-deferral benefits for after-tax, non-retirement monies used to purchase them. However, money invested outside an annuity in stocks/bonds is taxed at 15% (long-term capital gains tax) for most people. In contrast, cash withdrawn from an annuity is taxed at your ordinary income tax rate, which may exceed 15%.
2025 tax considerations: Under the OBBBA (One Big Beautiful Bill Act) signed in July 2025, seniors have enhanced standard deductions and a senior bonus deduction, but these don’t change the fundamental tax treatment of annuities. Withdrawals remain taxed as ordinary income.
Risk
One could argue that the most significant risk with annuities is not that you might buy an overly complicated or costly one (though that may not be a good thing), but instead buying something you don’t understand or realizing later that you didn’t really need.
Another risk is that you spend too much on one and then need a lump sum for an emergency or other need, leaving you without access to your cash without paying a surrender fee.
But the main financial risk is insurance company insolvency—the money invested in an annuity is only as “safe” as the insurance company you purchase it from. An insurance company could default. Granted, this doesn’t occur often, and annuities are regulated at the state level and insured, to a limited extent, by state guarantee funds. But no insurance company can guarantee that it will never go out of business.
If you need (or want) one
Most people I have spoken with who purchased annuities are reasonably satisfied with their decision. Those who aren’t happy with their decision often say they didn’t fully understand what they were buying and now regret it.
I once met with a couple who didn’t realize they had purchased a variable annuity to fund their IRA, and were so upset that they paid the surrender charge to exit it. I didn’t recommend one way or the other—I’m careful not to offer “advice” on some issues—but I made sure they understood their alternatives and that a surrender charge would apply if they wanted to withdraw from their annuity contract. They learned a hard lesson in this instance.
Sorry, but I can’t answer the question I posed in the title of this article. I can’t tell you if one of these products is right for you. They are somewhat esoteric and highly situational in terms of appropriateness. Even if there is a “fit,” it may not be the best option.
If you’re interested, seek wise counsel, consider all your options, and consider products from different providers. It’s essential to understand which annuity is best for you thoroughly, the specific product you’re buying, whether you need it, and the total costs (including all fees).
Here’s a checklist of things to help you shop for a fixed index or variable annuity, should you decide you need one:
- Check the terms. Annuity contracts are known (infamously) for their “fine print,” so be sure to read the contract carefully. You need to understand their terms and conditions, including surrender charges, optional riders, and other fees, not just the potential benefits that salespeople tend to emphasize.
- Choose your salesperson wisely. As noted above, insurance companies often pay generous commissions to brokers who sell their particular annuities, which most brokers don’t disclose. They also generally don’t reveal whether they are paid more or less by one insurance company than by another, or whether the annuity they are selling is the optimal option for their client. Ask your broker questions to determine how they are paid. You may want to seek a second opinion to ensure your salesperson isn’t steering you into a product that isn’t right for you.
- Select a sound insurance company. Annuity payments are often supposed to last a lifetime, so you want an insurance company that will stick around. Ensure the insurer is rated in the top two categories by a rating service, such as A.M. Best, Moody’s, Standard & Poor’s, or Weiss.
- Calculate total annual costs. Add up ALL fees (M&E, administrative, investment management, underlying fund expenses, and any riders). If the total exceeds 2.5-3.0%, seriously question whether the benefits are worth the cost drain on your returns.
- Compare with alternatives. Before committing, compare the annuity with: (a) a simple immediate fixed annuity for guaranteed income needs, (b) a low-cost diversified portfolio of index funds, or (c) a bond ladder or TIPS ladder for safe income. Often, one of these simpler alternatives will serve you better at a lower cost.
Wise as serpents…
Remember, annuities are simply tools to help you reach a specific goal or address a financial challenge. You may not need one, but it’s good to know how to shop for one if you decide you do. Even if you’re unsure whether you need one, and want one anyway, you should be a wise and informed consumer.
If you’re working with a financial advisor, ensure they have more than one tool in their toolkit. (To a salesperson who sells only annuity hammers, every retirement income challenge looks like a nail.)
Rather than a complicated and expensive indexed or variable annuity, you may be better off with a simple SPIA (especially now that immediate annuity rates are at their best levels in over a decade—see Part 1). Or, perhaps your best approach is to create a diversified portfolio of bonds, stocks, ETFs, and mutual funds focused on value and compound interest, and then let them do their thing. Only you (with wise counsel if necessary) can decide what is best for your situation.
If you decide to purchase an indexed or variable annuity, given the complexity and costs involved, it’s best to be “wise as serpents and innocent as doves” (Matt. 10:16). Be sure you understand the terms of the contract, differentiating between the “must dos” (contractual guarantees) and the “might dos” (based on market performance or other conditions).
Finally, read the fine print, even if you have to wait a few days to sign the contract. (You should probably do that even if you don’t read all the fine print.) And by all means, get wise counsel and perhaps a second opinion. Such efforts will eliminate surprises (and regrets) down the road.