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What are its disadvantages?

Variables have several drawbacks that can erode their advantages. For starters, there's a lot more risk associated with a variable annuity.

Investment risk: If the investments you choose for your annuity decline, the value of your annuity will also decline - and that means a lower payout to you.

Taxes: Then there are the taxes. As with fixed annuities, you'll pay taxes on a variable annuity's gains when you withdraw them, plus a 10% penalty if you're under age 59 ½. Variables also have another little tax twist: Any long-term capital gains you build up in stock and bond subaccounts are taxed at ordinary income rates when you withdraw them. This means that high-income investors are effectively converting long-term capital gains taxed into ordinary income that can face far higher rates.

Fees: And then there are variables' fees. Aside from surrender charges that dock you for early withdrawals, variables can also come with steep sales commissions (often 4%). Add ongoing management fees and insurance charges, which combined can run as high as 2% to 3% a year, and you're looking at one hefty load of fees cutting into your returns.

Compare that fee structure with regular no-load mutual funds, which levy no sales commission or surrender charge and impose average annual expenses of less than 0.50% (for index funds) or about 1.5% (actively managed funds).

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