Before you run out to buy a variable annuity, recognize their drawbacks.

First, because of the insurance layer, VAs come with relatively high price tags.

Second, variable annuities are only suitable as long-term investments. Experts estimate that an investor who is in the 28% tax bracket during the accumulation and annuitization periods and who owns a VA with a typical expense ratio would need to be invested for 10 to 15 years for the tax advantages to offset the high expenses. And that's assuming a comparison with a mutual fund with average tax efficiency, not with a tax-managed fund. In general, the more your investment grows and the longer you have until retirement, the more likely a variable annuity may make financial sense.

Next, while VAs offer current tax deferral, the IRS demands a trade-off: VAs are an estate tax liability. When you die, your heirs will owe income taxes on your account's appreciation. If you passed along fund or stock investments instead, those securities would be stepped up for tax purposes, meaning your heirs' cost basis would be the value of the investments as of your death, not their value when you purchased them. In the vast majority of cases, that would mean paying less in taxes.

Finally, one of the VA's perks--namely, the death benefit--is overrated. It isn't worth much for long-term investors. The odds of your account being lower in value after, say, 20 years are slim.

Next: Alternatives to Variable Annuities >>