Variable annuities enable investors to defer taxes on investment gains until money is withdrawn. Additionally, variable annuities have a death benefit guaranteeing the beneficiary a specified amount (usually the amount invested) upon the investor’s death. For a fee, most annuities offer “living benefits” guaranteeing a rate of return (usually 2 to 5 percent) over time. Upon withdrawal, payment can be taken as desired, or converted into a fixed periodic payment (annuitized). Funds withdrawn before age 59½ suffer a 10 percent penalty.

Annuity gains are ordinary income, currently taxed between 10 and 35 percent. While most investments receive a “step-up in basis” that eliminates or drastically reduces the taxes heirs must pay when selling inherited assets, annuities don’t receive a step-up in basis so heirs must pay taxes on the difference between the investment’s cost and current value.

Annuity salespeople are commonly paid an up-front commission ranging from 5 to 10 percent. Although the purchaser doesn’t pay the salesperson directly, the insurer charges the investor high recurring fees to recover this expense. Additionally, separate recurring fees are charged by both the insurer and the underlying funds. After adding the cost of living benefit riders to the contract, fees often exceed 3 percent per year. Comparatively, according to Morningstar the average domestic mutual fund charges 1.35 percent.

Another consequence of high commissions paid to salespeople is the attachment of a surrender charge to annuity policies. Surrender charges discourage investors from withdrawing funds before the insurer recovers the commission paid to the salesperson. This charge usually starts at 7 to 15 percent and commonly declines over 5 to 15 years.

Annuities are appropriate for specific circumstances, such as leaving assets to qualified charities or providing extremely risk-adverse investors with guaranteed income. If you believe an annuity would serve your purpose, it’s time to learn a well-kept secret: you can purchase an annuity without funding a salesperson’s vacation. No-load (no-commission) annuities commonly charge less than half the recurring fees of loaded annuities and have no surrender charge. No salesperson is going to discuss this option. A fee-only financial advisor who isn’t influenced by commission-based compensation can provide an objective opinion on whether an annuity is a wise investment and direct you to a no-load product.