This tax benefit extends to all cash-value life insurance products. However, insurance executives recognized that many people don't need the substantial insurance component of most cash-value policies and that these consumers were reluctant to pay for insurance just to get the tax benefits on the invested portion of a policy. So they flipped the traditional cash-value policy around: Instead of making the insurance element the primary focus, they made the investment portion predominant. In fact, with a variable annuity, the insurance element is not much more than a thin wrapper going around the investment simply to secure favorable tax treatment.

The investment side works like a 401(k) account or a variable universal life policy. You can choose from a range of investment options--from high-risk, high-return investments to those offering lots of safety and little in the way of income. Your ultimate return will reflect how well the investments you chose performed over time.

What does the insurance portion of the policy do? Generally speaking, the insurance promise you get is this: If you die at a time when your investments have lost money, your insurer will pay your heirs a death benefit that will make up for your investment losses.

To illustrate this point, consider a hypothetical consumer, Fred Unfortunate. Fred puts $100,000 in a variable annuity in December. He invests the funds in a stock account, and the stock market immediately tanks, causing Fred to lose $25,000 of his initial investment. The shock of this investment faux pas sends Fred into cardiac arrest. He dies.

But fortunately for his widow, the annuity insurer pays a death benefit of $100,000--the $75,000 remaining from Fred's investment and the rest from the insurance portion of the policy.

What would have happened had Fred's stock account risen in value before he died? His widow would receive the value of the account, and the insurance portion would not enter into the equation.

What if he'd owned the policy for years and his $100,000 investment had risen to $150,000, then had fallen by $20,000 at the time he died? Same deal. His widow would get the $130,000 value of the account and the insurance part wouldn't kick in. The insurance portion of most variable annuities guarantees only that, after your death, your heirs will receive at least what you put in. No more, no less. (A handful of insurers offer variable annuities that promise a minimum annual investment return, but they charge more for the insurance portion of the policy.)

Nonetheless, because there is that insurance promise, the income that accumulates in your variable annuity grows on a tax-favored basis. And that can be valuable. Just how valuable is hard to say, because the answer varies depending on tax rates and what portion of your investment earnings are likely to be subject to tax in any given year.

For a high-income taxpayer, the ability to earn compound investment returns on money that otherwise would be paid to the government in income taxes can be significant.

However, the insurance guarantee in a typical variable annuity will cost you about 0.6% more in fees than a similar investment without one, according to Morningstar Investments, an investment research firm headquartered in Chicago. In addition, most charge annual account fees from $30 to $40, which also diminish investors' total return.

* * * Still, if you're paying substantial income taxes and there are no other good investment options, those fees are inconsequential compared with the tax benefits. And it's not surprising that sales of variable annuities started taking off in the 1980s, after the federal government reduced the tax benefits of individual retirement accounts for people with higher incomes. Nearly $73 billion in variable annuities was sold in 1996, compared with about $9 billion in 1986, according to LIMRA International, a Hartford, Conn.-based research firm.

But the Taxpayer Relief Act of 1997 brought two key changes that could make variable annuities a tough sell.

First, long-term capital gains rates were pared to a maximum of 20%. So, people who own investments outside of tax-deferred accounts and meet the 18-month holding-period requirement face a much lower tax burden on any gain realized. Investment income taken out of a variable annuity, on the other hand, is taxed at your ordinary income tax rate, which is likely to be higher than the top capital-gains rate.

Second, the Roth IRA, a tax-favored retirement account that works like a variable annuity, was created. You put money in and the investment earnings in your account are not taxed unless you pull the money out too soon. You can shift your money among investment vehicles--in other words, you can transfer out of the stock account into the bond account or the international investment option--without tax consequences as long as the money stays within the Roth IRA wrapper.

* * * But the most compelling benefit comes at the back end: As long as your Roth IRA money is invested for at least five years and you don't pull it out before retirement, the money you withdraw at retirement is tax free. You will never pay tax on that investment income.

If, on the other hand, you invest through the variable annuity, you would pay tax at your ordinary income-tax rate at retirement.

However, you can only contribute to a Roth IRA if your income is below $95,000 if you're single or $150,000 for married couples filing jointly.

There are no income restrictions for contributions to a variable annuity. So if you earn too much to contribute to a Roth and trade too actively to enjoy the long-term capital gains rate afforded those with investment patience, a variable annuity could still make sense. For everyone else, there are probably better options.

* * * Adapted from "Kathy Kristof's Complete Book of Dollars and Sense." Printed with permission of Macmillan Publishing, New York. Write to the author in care of Personal Finance, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or kathy.kristof@latimes.com. KATHY M. KRISTOF welcomes comments and suggestions for columns but regrets that she cannot respond individually to letters and phone calls.