NEW YORK (CNN/Money) - I rolled over my IRA from a variable to a fixed annuity because I wanted my money to be safer. Is a fixed annuity safer than a variable?

-- Victor Seader, Las Vegas, Nevada

I'm happy to answer your question about fixed vs. variable annuities. But I then want to ask you a question that I think is even more important than the safety issue you're raising.

Let me start by explaining the difference between a fixed annuity and a variable annuity.

A fixed annuity is a contract offered by an insurance company that is much like a bank CD. You deposit a certain amount of money and the insurer agrees to pay a certain interest rate over a specified period of time.

But there are a couple of twists that make a fixed annuity slightly different. On the plus side, unlike with a bank CD, the interest you earn in a fixed annuity isn't taxed until you withdraw the money from the annuity. If you withdraw those fixed-annuity interest earnings before age 59 1/2, however, you'll not only pay income tax, but a 10 percent penalty.

In addition, insurers typically charge an early withdrawal penalty for withdrawals made within the first seven to 10 years that you own the annuity. These early withdrawal penalties can start as high as 10 percent or so (even higher in some cases) and then usually decline by a percentage point or so until they disappear after seven to 10 years.

A variable annuity, by contrast, works more like a mutual fund. You invest in one or more "subaccounts," which can own stocks or bonds or a combination of stocks and bonds.

Often, these variable annuity subaccounts are modeled after or even go by the same name as retail mutual funds. There are some important differences, though, between a mutual fund and a variable annuity. For one thing, a variable annuity has an extra set of fees -- usually known as insurance costs or M&E (mortality and expense) charges -- that given them higher annual operating expenses than mutual funds. Frequently, the combination of the investment management fees to run the underlying investment portfolio plus the insurance charges drive a variable annuity's annual costs above 2 percent a year.

Another important difference is in the way variable annuities' gains are taxed. As with a fixed annuity, any earnings remain untaxed as long as they remain in the variable annuity.

Upon withdrawal, however, the earnings are taxed as ordinary income. You'll pay a 10 percent penalty if you withdraw earnings before age 59 1/2.

But there's a twist. Even if the earnings in your variable annuity are the result of long-term capital gains, those earnings will still be taxed at ordinary income rates (which can run as high as 35 percent) rather than at long-term capital gains rates (which can not exceed 15 percent), as is the case in a mutual fund.

So variable annuities effectively convert long-term capital gains to ordinary income, which is a distinct disadvantage because it boosts the share of your gains that go to Uncle Sam. As with fixed annuities, insurers also charge early withdrawal penalties if you pull out money within the first seven to 10 years or so.

As far as safety, then, the difference between investing in a fixed annuity vs. a variable is rather like the difference between investing in a bank CD vs. a mutual fund.

A fixed annuity provides more security of principal than a variable annuity, but has limited upside potential. When you invest in a variable annuity, you accept more short-term volatility in that the value of your investment will fluctuate with the stock and bond markets. But you have a shot at higher returns. So it's the old risk vs. return tradeoff.

The more important question, though, why are you investing IRA money in an annuity in the first place? After all, the IRA already shelters your earnings from taxes. And it does so without you having to pay the additional layer of fees that annuities charge.

So I contend you're better off keeping your money in a bank CD or mutual fund within the IRA and getting the tax-deferral benefit at a lower price.

In fact, I can think of only one good reason why you might want to own an annuity within your IRA. And that reason is that you want to use some portion of your IRA funds to create an income you won't outlive.

You would do that by buying a "payout" or "immediate" annuity, essentially an investment that converts a lump sum of cash into a stream of income guaranteed to last as long as you live or, if you wish, as long as either you or your spouse or some other person you designate is alive. But, in my opinion at least, it makes little sense to do this until you're actually retired or on the verge of doing so.

Unfortunately, there are many sales people out there who are only too eager to take IRA money that sits in CDs and mutual funds and roll it into annuities.

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I can't say whether they do that because they really believe it's a good thing to do or because such a transfer results in a nice commission for them -- but I can say that, aside for the reason I noted above, I don't think it's a very good idea.

And even if you want to use an annuity to create a lifetime income using money in an IRA or IRA rollover, you've got to proceed carefully to make sure that high fees don't end up siphoning off too much of that income.

If you want to learn more about what role, if any, both fixed and variable annuities can play at various stages of retirement planning, you may want to consider checking out my new book, "We're Not In Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World", which devotes a good portion of two chapters to annuities.

Bottom line: annuities have some unique advantages that allow them to do what no other investments can do. But unless you understand how they operate and also understand what their considerable drawbacks are, you may end up with more of annuities' downside than their upside.

Walter Updegrave is a senior editor at MONEY Magazine and is the author of "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."