Unlike a fixed annuity that offers a fixed rate of return determined by the issuing agency - in a variable annuity you are able to select from a variety of investment products, stocks, mutual funds etc - that your contributions to the annuity are put into. In this way the difference between a fixed annuity and a variable annuity is much like the difference between a Whole Life insurance policy, and Variable Life insurance.

The main advantage to variable annuities is that they offer a better investment potential, and opportunity for real long-term capital growth. You can do this by selecting that your money be put into up to 20 different investment products called sub-accounts. Of course as with their fixed counterparts any contribution or gains are tax-deferred until maturity. Because of their variable nature, it is far more likely that a variable annuity will keep pace with, or maybe even outpace inflation

So what are the downsides? First of all risk. By their very nature, variable annuities are intrinsically riskier investments then fixed annuities. If the investments you pick do poorly, your annuity fund will loose value, and your eventual payouts will be lowered

Other Disadvantages of Variable Annuities

• Taxes - While it is true that taxes are deferred with variable annuities as in all annuity products, the gains you make in your sub account investments are taxed as income, rather then at the lower capital gains rates, once you withdraw them.
• Fees - Besides brokers commissions, variable annuities can have many maintenance fees associated with them, these can amount to as much as 3% annually.

If you are hoping for a bigger potential payout than you can get with a fixed annuity and feel you can do better pinning those hopes on the markets over the long-term, and want to have some control over your investments, then a variable annuity may be right for you.

Note: There is a kind of hybrid product known as an equity-indexed annuity. An equity-indexed annuity has been designed to give those interested in annuity savings for retirement the "best of both worlds". These annuities offer the guaranteed rate of return of a fixed annuity albeit a lower one- usually in the neighborhood of 2-3%. But that rate also has the opportunity to increase, because the value of the fund is also tied to the performance of some benchmark index such as the Dow or the Standard & Poor's 500. With an equity-indexed annuity, you get the benefit of a bull market, but can't drop below a certain fixed rate if stocks take a dive. Generally speaking, equity-indexed annuities perform better than fixed annuities, but not as well as variables.