An annuity is a series of payments. If the amount of the annuity varies, it is called a variable annuity. Life insurance companies sell variable annuities, which are tax-deferred investments. If you buy a variable annuity, you select from a range of mutual fund-like investments called subaccounts.

A subaccount's investment performance determines the future value of a variable annuity. Subaccounts are often conservative funds that invest in bonds with the highest credit rating. Some annuities also offer subaccounts that invest in stocks.

You should carefully read the prospectus of an annuity and the subaccounts that you select before investing. The investment objective shown in the prospectus indicates the kinds of investments that the fund buys.

In addition to resembling mutual funds, annuities also resemble life insurance. Similar to a life insurance policy, you name a beneficiary to receive a death benefit if you die. Fees for a variable-annuity contract also resemble those of a life insurance policy:

• Surrender charges. A surrender charge is a fee that you pay if you sell an annuity contract within a certain number of years. Surrender charges can be as high as 9% of the purchase payment, usually falling by 1 percentage point each year.
• Mortality and expense fees. Mortality and expense (M & E) fees, or risk charges, are paid yearly to the insurer to adjust for changes in the risk characteristics of its pool of insureds. M & E fees routinely add up to about 1.25% of an annuity's contract value.
• Administrative fees. A variable annuity's administrative fees are often charged at a flat yearly rate of $30 to $50 per contract.

It's important to remember that variable annuities are already tax-deferred investments. As a result, you receive no additional tax savings if you buy them for other tax-advantaged accounts.

The Securities and Exchange Commission (SEC), which regulates the variable-annuities industry, advises that you only buy variable annuities after you contribute the maximum allowable amounts to your IRAs and other tax-advantaged accounts.

Because variable annuities have high fees and are taxed as ordinary income, it takes a long time for their returns to match the investment returns of other tax-advantaged accounts. However, variable annuities may be attractive for long-term investors in some cases since they offer the following features:

• Income security for a spouse or other beneficiary. An annuity is a series of payments that continues until you die. For an extra fee, you can buy a joint-and-survivor annuity option benefit. This benefit continues to pay an annuity to a spouse or other beneficiary if you die first.
• Tax-deferred growth. Variable annuities allow you to make nondeductible contributions that grow tax-deferred until you begin to take withdrawals. Similar to other tax-advantaged accounts, variable annuities have an early-withdrawal penalty if you take out money before you reach age 59-1/2.
• No contribution limits or required distributions. There are no restrictions on how much in variable annuities you can buy. Also, variable annuities don't have required minimum distributions (RMDs).
• Death benefits. If you die before you begin to receive an annuity, or before a certain period, your beneficiary continues to receive the annuity as a death benefit. The amount and duration of the death benefit are determined by your total contributions, deducting any annuity payments you may have already received.

You may wish to keep in mind these additional tips:

• Section 1035 exchanges. You can usually make tax-free exchanges using a Section 1035 exchange. However, if you do a 1035 exchange, you will likely inherit a new surrender-charge schedule, as well as owe any surrender charges on the contract you are selling.
• Insurer's credit rating. Variable annuities are only as financially stable as the insurance company that sells them. You should check the insurer's credit ratings. Aim for those annuities sold by insurers with credit ratings of single-A or higher.

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.