When it comes to planning and saving for retirement, everyone's situation is different. Your risk tolerance, time horizon, tax situation, assets and financial knowledge all play important roles in how you should grow your nest egg.

So can a variable annuity get you toward the retirement you deserve? Learning about the features, benefits and drawbacks of variable annuities can help you make an informed decision about whether they'll be a good fit for your retirement portfolio.

What Is a Variable Annuity?

An annuity is a financial product issued by an insurance company that helps provide a fixed income, often to retirees. You buy the annuity and fund it (either through a lump sum purchase or a series of payments), and the provider returns it in regular payments starting now or at a date you choose. A variable annuity is called that because it does not supply a guaranteed return, as its returns are tied to a portfolio of mutual funds.

Like other annuities, such as tax-deferred annuities and indexed annuities, variable annuities help people manage income. They also enjoy tax-deferred growth and provide death benefits to beneficiaries. But variable annuities have a few unique twists that buyers need to know.

How Do Variable Annuities Work?

Variable annuities differ from fixed annuities in a few key ways.

• When you buy a variable annuity, you choose how to invest. You can choose between six and 20 investments, which are called subaccounts and are similar to stock or bond mutual funds.
• Unlike fixed annuities, payouts vary depending on contributions, return rates and expenses.
• The value of a variable annuity is based on the performance of its investment portfolio of investments. By comparison, fixed annuities base payouts on a set interest rate, and indexed annuities base payouts on a specific market index.
• Investment gains from variable annuities are taxed differently than traditional annuities.

Risk and Return

Variable annuities could yield higher returns than other annuities. If the stocks and bonds in the subaccounts do well, you'll see more money from the annuity.

But variable annuities also carry greater risk. If the underlying investments lost value, your annuity loses value, too, and you'll receive less in each payment. If the other investments in your retirement portfolio are market-dependent, a variable annuity could push your total market risk even higher.

Fees and Taxes on Annuities

Before considering variable annuities for your retirement portfolio, it's important to understand their fees and tax implications.

As with fixed annuities, withdrawals from variable annuities are taxable — and this includes a 10% penalty if you're under 59 1/2. However, capital gains from variable annuities are also taxed — and they're taxed at your ordinary tax rate, not the tax-preferred capital gains rate.

And the fees and commissions on variable annuities can be much higher than they are on other retirement savings options. Commissions on variable annuities could reach as high as 4%, and management fees could be 2% or 3%.

When to Choose a Variable Annuity

Despite the taxes and potentially high commission rates, variable annuities could be right for some retirement planners. Maybe you've maxed out your 401(k) and individual retirement account contributions and you've invested in low-fee index funds or other tax-preferred retirement investments. Or maybe you're comfortable with the higher risk of a variable annuity given its potential for greater returns.

A variable annuity is just one way to diversify your portfolio. Though they offer greater returns that could outpace inflation and other investments, variable annuities also come with higher risk, fees and taxes. They might not be suitable for every retiree. Talk to an advisor about whether this financial tool is a good fit for your retirement plan.