(FORTUNE Magazine) – TAX-DEFERRED VARIABLE ANNUITIES COULD BE CALLED the cockroaches of the investment world. Personal finance columnists rail against their high fees. Many financial advisors question their purported benefits. And the SEC and NASD issued a blistering report in June that lambasted the annuity industry for high-pressure sales tactics and failing to disclose exorbitant early withdrawal penalties. Yet none of that has threatened the survival of this investment species. Just the opposite: Investors have snapped up some $50 billion in variable annuities over the past 12 months, bringing the total invested in them to more than $1 trillion.

The annuity industry has been trying to clean up its image of late, touting "new and improved" offerings. That raises the obvious question: Just how new and improved are they? The answer: The changes, as you'll see, are mostly cosmetic. With a handful of exceptions, the investments simply do not make sense for most people.

Let's start with the basics. Tax-deferred variable annuities are essentially mutual funds with two added features. First, your investments are protected from taxes until you cash them in. Second, the investments are wrapped inside an insurance policy that protects against catastrophic investing losses and death. Insurance agents, stockbrokers, and financial advisors love to push variable annuities as the epitome of safety and security. But when you actually do the math, the glow of reassurance quickly fades. Consider:

●The fees you pay often exceed the taxes you avoid. An investor who buys a regular mutual fund for a taxable account pays an annual expense ratio that averages about 1.4% for an actively managed fund or 0.3% for a passively managed index fund, such as one that tracks the S&P 500. But the average total expense ratio on a variable annuity is a whopping 2.3%, according to Morningstar. That pays for the insurance coverage that goes with the annuity (more on that in a moment) and the fat commission the salesperson gets for selling it. In today's low-return environment--a ten-year Treasury bond now yields 4%--it's practically investment suicide to pay annual fees of this magnitude.

I asked William Reichenstein, a Baylor University finance professor who has researched variable annuities extensively, to run the numbers for a hypothetical investor who wants to put money into a bond fund. Reichenstein assumed that the fund would generate an average annual return of 5% that would be taxed at a 28% rate. He also assumed an annual expense ratio of 0.3% for a bond index fund and 2.1% for the bond fund within an annuity.

Here's how the numbers shake out: The taxable bond fund will generate a 3.4% annual return after tax (5% less the 0.3% expense ratio and 28% tax). The annuity, meanwhile, will generate an annual return of just 2.9% (5% less the 2.1% expense ratio)--and that's before deducting the taxes that our investor will owe when he cashes out the annuity. Put another way, in after-tax terms, $100,000 invested in the taxable fund in our example would return $195,000 over 20 years, while the comparable annuity would give him $156,000. As Reichenstein points out, the longer the investor holds the annuity, the bigger its disadvantage becomes.

●Getting in is a lot easier than getting out. The vast majority of variable annuities have "surrender charges," which wallop owners with a steep penalty (up to 9% of the total annuity amount) for withdrawing their money during the first seven years. That's not something you'd pay with a typical mutual fund. Moreover, Uncle Sam doesn't want you to withdraw the money until you're nearing retirement. If you cash out before age 59½, you'll not only owe taxes but also have to pay a 10% penalty to the IRS.

●This insurance policy almost never pays. What about the insurance benefit that goes along with these variable annuities? It provides peace of mind, in theory. But does the policy actually pay off? Rarely. Variable annuities typically offer a "death benefit." Such a provision guarantees that after you die, your heirs will collect the annuity's account balance or the amount you originally invested, whichever is greater. So your loved ones are shielded from a devastating plunge in your investments. But for this insurance benefit to kick in, this major portfolio loss must occur close enough to your death that your investments don't have time to recover. That's certainly not impossible, but it becomes more of a stretch the longer you stay alive, since even mediocre investments are likely to accumulate positive returns over time. Indeed, according to research conducted by Moshe Milevsky, a variable-annuities expert at York University in Toronto, the value of the death benefit associated with the average variable stock annuity is worth only about 0.2% in additional fees each year--a far cry from the 1.25% typically charged. The insurance benefit on a bond fund would be worth even less.

●The "improvements" are dubious. Take for example, so-called living benefits, one of the "new and improved" features. Offered in a dizzying array of styles and flavors, they guarantee investors a minimum annual withdrawal throughout their lifetimes--typically 4% to 7% of the account balance at the time withdrawals begin. But that assurance, of course, comes at additional cost (about 0.4% in the usual case), which itself falls on top of the annuities' regular fees. That means the net return will be "virtually worthless," in Milevsky's words, if the guaranteed return is 4%. If, he says, you're lucky enough to be offered a 7% minimum rate (equivalent to about 4.3% after fees), it's worth considering. But beware: the higher the rate, the greater the chance that exorbitant fees will be attached. "Is that the only way to make investors feel comfortable enough to invest in equities--to put their money into a tax environment that is unfavorable in many ways, and with high expenses?" asks Glenn Daily, a New York insurance consultant. "That's not the best we can do."

Another recent trend in the annuity industry is to offer investors "sign-up bonuses" equal to, say, 3% of the amount they invest. These deals are especially common in situations in which investors want to switch out of a poorly performing annuity into another one. But these "bonuses" are almost always wiped out by the accompanying higher fees and longer surrender periods. And there are even more bells and whistles available. Some annuities tack on other kinds of insurance--such as long-term care and disability--which can be purchased more cheaply and effectively on their own.

●You may save on taxes, but your heirs won't. If your game plan is to leave a good chunk of your savings to your loved ones, variable annuities are a poor choice. That's because federal law actually favors taxable investments in this instance. A special IRS provision "steps up" the cost basis on a taxable account when you die, so your heirs inherit the investments at their current value, without owing taxes on the gains that occurred during your lifetime. With variable annuities, by contrast, your heir is liable for the full taxes. "It's a very unattractive asset to have taxed in your estate," says Alice Odorico, who heads up the insurance advisory practice of the J.P. Morgan Private Bank.

●Even low-cost annuities may not be so cheap. Not all variable annuities carry high expense ratios. Low-cost providers such as Vanguard and TIAA-CREF account for about 5% of the market. Because they sell directly to the consumer, there are no heavy sales commissions baked into their expense ratios. (Of course, not having a commissioned sales force to push their annuities may also explain the puny market share.) As a result, the total expense ratios on these annuities averages only about 0.7%.

But even these more modest fees are a major drag on performance. Reichenstein crunched the numbers again--this time assuming that our investor put $100,000 in a bond fund and that the annuity carried a 0.7% annual expense ratio. The result: After 20 years, the taxable bond fund would have grown to about $195,000 after tax. The annuity, meanwhile, would have grown to $232,000 before withdrawals; once the tax was paid on the annuity's earnings, he'd have netted about $195,000--the same as the taxable fund. It's only after that 20 years that the investor would be better off in the annuity, says Reichenstein. At that point the benefits of the tax deferral would overcome the annuity's higher expenses. Annuities look even worse if you base your comparison on equity investments, because stocks in a taxable account are subject to capital gains rates, which are lower than the rates in our bond example.

So if you're willing to lock yourself into a multidecade time horizon and you pick a low-cost option, an annuity could make sense. But even then, don't jump into one until you have first maxed out on all available tax-deferred retirement plans, such as a 401(k) or a 403(b) offered by your employer or a Keogh or SEP-IRA retirement plan if you're self-employed. Contributions to these plans are made with before-tax dollars, allowing you to shelter significantly more income than you can with an annuity. And you may also receive a company matching contribution--free money that you don't get with an annuity. And after you've topped out your employment-related retirement plans, contribute (if you're eligible) to a Roth IRA. You'll fund it with after-tax dollars, but then all your earnings and withdrawals will come tax-free. Then--and only then--should you consider a variable annuity.