Variable annuities are often promoted as a secure way to generate guaranteed income during retirement, drawing the attention of retirees seeking stability for their nest eggs. But beneath the surface, these products frequently come with complications and costs that can erode your savings and limit your financial flexibility. In this episode, I share the details of the often-overlooked downsides of variable annuities and give you some important insights every investor should consider.

• [03:14] What is a Variable Annuity?
• [04:27] Understanding Annuity Benefits and Growth
• [08:41] Lack of fee transparency in annuities
• [09:45] Variable annuity investment drawbacks
• [14:59] Avoiding variable annuity pitfalls

A variable annuity is an investment product sold by insurance companies, offering a selection of investment accounts, referred to as sub-accounts, designed to mimic mutual fund performance. The tax-deferred growth inside the annuity is often touted as a major benefit. This tax deferral is redundant for retirement investors who already enjoy similar benefits in IRAs or 401(k)s.

Many variable annuities advertise living benefits, such as guaranteed lifetime withdrawals. For instance, a $100,000 investment could guarantee $5,000 per year for life, regardless of the contract's cash value. Some contracts offer guaranteed "growth" of your future income base, but crucially, this is not money you can cash out: it simply determines your withdrawal amount, not your walk-away value. The catch is that these appealing features come at a steep price.

One of the most significant drawbacks of variable annuities is their high-cost structure. These costs can be organized into three main categories:

• Mortality and Expense (M&E) Charges: Annual administrative fees imposed by the insurance company, typically ranging from 1% to 2% per year.

• Sub-Account Fees: Investment management fees that vary depending on your chosen investments. While some options are slightly less expensive, others can reach up to 2% annually.

• Rider Fees: If your contract includes a guaranteed income benefit, expect an additional 1%-2% per year for this privilege.

Combined, these expenses can easily total 3% to 4% annually, making variable annuities arguably the most expensive retirement investment around.

Transparency is another major shortfall in the world of variable annuities. Many investors are not fully aware of the high fees they're paying. While the fees are listed in the prospectus, many advisors fail to highlight them, and statements often obscure these charges. Understanding true costs requires diligent reading of the fine print, and even then, variations in sub-account performance can lead to unexpected results. You may believe you're mirroring mutual fund returns, but annuity sub-accounts are not identical and can significantly underperform.

The promise of guaranteed income comes at a heavy cost. For the insurance company's guarantee to pay off, you'd generally need to either live well beyond average life expectancy or experience long-term poor market performance. Since withdrawal rates are limited and fees are high, over the long run, variable annuities may yield less retirement income or reduce the amount left to your heirs.

Variable annuities can be marketed to highlight only the positives, but it's important to consider the high fees, lack of transparency, poor risk-return tradeoff, inflexibility, and opportunity costs involved. Before committing your retirement savings, do your homework—or consult a truly fiduciary advisor—and make sure variable annuities are the best fit for your long-term goals.

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