Variable Annuities: Market Growth Potential with Insurance Protections

A variable annuity is a long-term, tax-deferred retirement vehicle that allows you to invest your money in various sub-accounts, which are similar to mutual funds. Unlike fixed annuities that offer a guaranteed interest rate, the value of a variable annuity fluctuates based on the performance of the underlying stocks, bonds, and money market instruments you select. For 2026 retirees, variable annuities are often viewed as a way to participate in market growth while retaining certain insurance features, such as a death benefit or guaranteed income riders.

I. The Accumulation Phase and Sub-Account Investing During the accumulation phase, your contributions are allocated to sub-accounts that you choose based on your personal risk tolerance. These sub-accounts provide the “variable” nature of the annuity; if the market performs well, your account value grows, but if the market declines, your balance will also drop. In 2026, many variable annuities offer a wide array of sub-accounts, ranging from aggressive global equity funds to conservative bond and money market options. This allows you to create a customized asset allocation within the tax-deferred “shell” of the annuity contract.

II. Tax-Deferred Growth and Ordinary Income Treatment The primary tax advantage of a variable annuity is that any investment gains, dividends, or interest earned within the contract are not taxed as long as they remain in the account. This allows for faster compounding over time, as money that would have gone to the IRS each year stays invested. However, when you withdraw funds, the earnings are taxed as ordinary income rather than at the more favorable capital gains rates. In 2026, this makes variable annuities particularly attractive for high-income earners who have already maximized their contributions to other tax-advantaged accounts like 401(k)s and IRAs.

III. Death Benefit Protections and Enhanced Riders A standard feature of most variable annuities is a guaranteed minimum death benefit. This ensures that if the owner passes away during the accumulation phase, their beneficiaries will receive at least the original amount invested (minus any withdrawals), even if the market has significantly decreased the actual account value. Additionally, many 2026 policies offer “stepped-up” death benefit riders, which periodically lock in market gains. For example, if your account grows from $100,000 to $150,000, a stepped-up rider can ensure $150,000 becomes the new guaranteed floor for your heirs.

IV. Guaranteed Living Benefits and Income Riders To combat the risk of market volatility, many variable annuities offer optional “living benefit” riders for an additional fee. These riders, such as a Guaranteed Minimum Income Benefit (GMIB), provide a floor for your future retirement income regardless of how the sub-accounts perform. In 2026, these are popular among retirees who want the upside of the stock market but also need a “safety net” that guarantees a certain monthly check for life. These riders often include a “roll-up” rate, which increases the future income base by a set percentage (like 4% or 5%) every year until you begin taking withdrawals.

V. Understanding Fees, Expenses, and Surrender Charges Variable annuities are known for having complex fee structures that can significantly impact net returns. Common costs in 2026 include Mortality and Expense (M&E) risk charges, administrative fees, sub-account management fees, and the costs of any optional riders. Additionally, most contracts include a surrender period (often 7 to 10 years) during which withdrawals exceeding a certain amount—typically 10% per year—incur a penalty. Because of these potentially high costs and liquidity restrictions, variable annuities are generally viewed as a long-range retirement tool rather than a source of emergency funds.

Source: SEC – Investor Guide to Variable Annuities; Morgan Stanley – Understanding Variable Annuities 2026