The Variable Annuity Money Pit
Tuesday, December 30, 2025 - Episode 525
Now let's talk about variable annuities, which might be the most cleverly disguised fee machine the financial services industry ever invented. And I say that with the kind of admiration you'd give a con artist who manages to pick your pocket while shaking your hand.
Here's how they work, and pay attention because the industry counts on you not understanding this. When you buy a variable annuity, your money goes into what they call separate accounts. Not mutual funds. Separate accounts. Why the fancy terminology? Because the law requires it. Insurance products can't technically hold mutual funds directly, so they create these separate accounts that are, for all practical purposes, mirror images of mutual funds. Same stocks. Same bonds. Same management. Same everything. Except the price tag. Think of it this way: you're buying a name-brand product repackaged in a fancier box, and someone's charging you a premium for the privilege of the new label.
The separate accounts inside your variable annuity hold the exact same investments you could buy in a regular mutual fund, but now you're paying extra layers of fees that would make a toll road operator blush.
Let's walk through the damage. First, there's the mortality and expense charge, which sounds like something from an undertaker's invoice. This typically runs about 1.4 percent annually. That's the insurance company's cut for providing the annuity wrapper and taking on some actuarial risk. Fair enough, you might think. Except we're just getting started.
Next come the riders. Income riders guarantee you a certain payout down the road. Death benefit riders promise your heirs won't lose money if you die while the market is down. These sound wonderful in the sales presentation, and they're not free. Each rider might cost you another half percent to one percent per year. Sometimes more. Stack a couple of these on top of your mortality charge, and suddenly you're looking at total annual expenses of three and a half to four percent.
Let me put that in plain English. If your variable annuity earns seven percent in a given year, and you're paying four percent in fees, you keep three percent. The insurance company keeps four. You did all the investing. You took all the risk. They took more than half the return. If that arrangement sounds fair to you, I've got a bridge in Brooklyn I'd like to discuss.
But wait, as they say in those late-night commercials, there's more. Many variable annuities require you to keep a certain percentage of your money in bond funds. The sales pitch calls this risk management or asset allocation. Here's what it really means: when interest rates are low and bond returns are anemic, you're stuck in investments returning maybe four or five percent while paying three and a half percent in fees. Your net return might be one percent. In a good year. Meanwhile, inflation is eating your purchasing power for breakfast, and the insurance company is still collecting their cut like clockwork.
Consider this example. You put two hundred thousand dollars into a variable annuity. Over twenty years, assuming average market returns of eight percent but total fees of three and a half percent, you'd net about four and a half percent annually. Your account might grow to roughly four hundred eighty thousand dollars. Sounds decent until you realize that the same two hundred thousand in a low-cost index fund charging a quarter of one percent would have grown to approximately six hundred eighty thousand dollars. That's two hundred thousand dollars that evaporated into fee structures and rider charges. Two hundred thousand dollars you'll never see because someone convinced you that complexity equals sophistication.
Here's another way to look at it. If you're sixty years old and you live to ninety, those annual fees compound into a small fortune you're handing to the insurance company instead of your grandchildren. Over thirty years of retirement, a four percent annual fee drag on a five hundred thousand dollar portfolio amounts to hundreds of thousands of dollars in lost wealth. Not lost to bad investments. Lost to fees.
Variable annuities aren't inherently evil. For a small slice of the population with very specific needs, they might make sense. But for most folks, they're an expensive solution to a problem that could be solved more simply and cheaply. The question you should always ask is this: who benefits most from this complexity? If the answer isn't you, maybe it's time for a different approach.