At one time, annuities may have looked like an ideal retirement vehicle: you put in a lump or periodic sum, the principal is "guaranteed" with an insurance benefit, and the headline in the brochure claims you'll receive "$4,000 a month for life" - this of course seems like plenty to live on in your golden years.

But annuities have somewhat lost their glow. There are several reasons for this, including:

1. Market performance.
2. "The fine print" on returns.
3. Hidden costs.

Every retirement vehicle (to be fair to annuities) has become less certain due to the less predictable, lower-returning mutual funds underpinning most of them. Annuities are no exception. Global uncertainty is always a possibility, and U.S. equities undergo cycles that are not always predictable. 
  Why Are Annuities Attractive?
For people absolutely disinterested in managing their own finances, annuities offered a simple menu. The participant must decide on only three things: lump or periodic inputs (contributions), deferred or immediate income, and fixed or variable returns.
  Many investors have chosen variable over fixed annuities at times when roaring mutual funds usually mean high returns compared to the conservative and seemingly "safe" fixed option. In the fine print, "fixed" usually means the returns will be re-evaluated in 1-5 years due to market variances. Contracts simply can't guarantee 6% if the fund manager is only making all-in yields of 5%.
  Why Have Annuities Lost Their Glow?
The old joke about annuities is that you make a fortune on the headline and then the fine print takes it all back. In many cases, this hasn't been too far from the truth. Introductory rates may be like 0% interest on car loans, and are indeed much like loss leaders in a supermarket promo. Those large promises suddenly evaporate after the first six months or a year when rates are adjusted and fees kick in.
Here are a few of those fees that can be buried deep within an annuities contract, or not shown at all:

• Commission - An annuity is basically insurance, so some nice sales person get a cut of your return or principal for selling the policy to you.
• Underwriting - These fees go to those who take actuarial risk on the benefits.
• Fund management - That's right, if the annuity invests in a mutual fund as most do, the management fees are passed on to you.
• Penalties - If you are under 59.5 and need to pull your contributions out, the IRS will get 10% and the contract writer will ask for a "surrender charge" between 5 and 10%. Better writers have declining surrender fees at lower percents, and allowances for 5-15% emergency withdrawals without penalties. You cannot borrow against your contributions, but Uncle Sam will let you transfer the funds to another insurance company without penalty (let your accountant handle this, if the check comes to you first you could be in trouble).
• Tax opportunity cost - Granted, annuities are one of the few remaining dinosaurs in the endangered species known as tax shelters. However, producers advertising them as "tax deferred" may not be quick to tell us that this is not the same as a 401(k) tax benefit. Even if the annuity manager is careful to meet all the regulations that allow your (after-tax) dollars to return deferred, the benefits cannot compete with putting pre-tax dollars into your 401(k). Any investment like an annuity should begin only where your 401(k) ends, when you've maxed out on contributions. This is doubly true if your employer is matching contributions.
• Tax on Beneficiaries - If you leave your mutual fund to your kids, the IRS allows them to take advantage of a step-up valuation, or the market price of the securities at time of transfer. This doesn't work with annuities, so your beneficiaries are likely be charged taxes at the gain from your original purchase price. There are ways to soften this blow with estate planning.

Reasons to Invest in Annuities?
After all the downsides and hidden costs, there are still a few upsides:

• No heavy record-keeping requirements.
• A legitimate tax shelter.
• Tax-free transfers between annuity companies.
• No investment limits.

Conclusion
After all consideration of pros and cons, it's important to remember that your entire investment in an annuity, or much of it, can be lost if the quality of the company behind the contract isn't sound. Low fees and high-quality writers increase the safety of your contribution and long-term happiness with your annuity.

by Investopedia Staff, (Contact Author | Biography)

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