Up until now, we've talked about how to use reasonably run-of-the-mill investments--stocks and mutual funds--in your portfolio.

In the 400 level of Investing Classroom Portfolio, we'll explore other types of investments that you might choose for your portfolio.

This lesson will focus on annuities: specifically, those of interest to long-term investors--the tax-deferred, variable kind.

Variable annuities are essentially mutual funds wrapped in an insurance package. When you buy a variable annuity, you can direct your investments into a range of stock or bond portfolios, called subaccounts, made available within a particular policy.

Why choose a variable annuity (VA) policy over mutual funds or stocks? VAs have two selling points.

First is the death benefit, or insurance that when you die your heirs will receive the greater of your initial investment or the account's current value. In other words, if the account is worth less when you die than when you initially invested in it, your heirs will get what you invested. That won't happen with a mutual fund or a basket of stocks.

Second, your contributions grow tax-deferred until retirement. You can elect to take your gains in a lump-sum distribution, or you can choose to receive annuitized payments in retirement. In other words, the money invested in the VA is systematically returned as a guaranteed income stream.

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.

Other types of accounts offer tax deferral, and more besides. Tax-deductible IRA contributions, for example, lower your current taxable income in addition to sheltering future gains from taxes. The same goes for 401(k) contributions, and you likely get an employer match as well. Of course, there are limits to how much you can place in such tax-sheltered accounts. Some investors use VAs once they've contributed all they can to their various retirement accounts.

But even once you've met those limits, the VA isn't your next logical choice. Set up a Roth IRA if you qualify. Like the VA, contributions are taxable. Unlike the VA, appreciation is not only tax-deferred, it's tax-free even after you start making withdrawals. And a Roth is much more flexible--you can withdraw contributions for any use at all. With the VA, you'd incur an IRS penalty and likely a surrender fee as well.

So you've invested as much as you can in your 401(k) and are socking as much into a Roth IRA as the IRS will let you, and you're still clamoring for shelter. What other options do you have?

Consider tax-managed mutual funds. And buy-and-hold stock investors can minimize taxes by sticking with high-quality non-dividend-paying stocks--if you don't sell, you won't trigger a taxable event.

Maybe you're comforted by the death benefit that VAs offer, or you like the annuitization feature, or you've exhausted all other tax-deferral options. What are the keys to successful VA investing?

First, buy for the long term. Remember, a VA needs time to overcome the fact that its gains are eventually taxed at the higher income rate, not the lower capital-gains rate. Furthermore, most VAs impose hefty surrender charges that start at 7%, decline each year, and vanish after a period of years.

Then, pay attention to how much you pay for a VA. Yes, the average VA levies higher fees than the average mutual fund, but some VAs cost much less. The low-cost leaders here--including Vanguard and T. Rowe Price--will be familiar names to thrifty mutual fund shoppers. In fact, their variable annuities charge less than many mutual funds, insurance wrapper and all.