Much to weigh before investing in annuities

In recent weeks we've gotten a number of questions about annuities. The annuity market is a complex universe with seemingly countless variations and shades of products. I thought it would be useful to lay out a perspective on annuities in this column.

Anyone approaching retirement should become familiar with the so-called life annuity -- also known as an immediate annuity and income annuity -- even though it is far from the right product for everyone. I'm wary of many other types of annuities. They tend to be more niche solutions than mass-market products.

In essence, with a life annuity you'll invest a sum of money and, in return, get a predictable monthly (or quarterly or annual) income on the investment for the rest of your life. The attraction is that you can't outlive the investment or the income.

That said, life annuities aren't simple. The price of flexibility is that there's a lot to consider before investing in one. You'll want to work with a company with a blue chip balance sheet. You'll need to shop around, since your stream of income depends on how much you invest, your age, the interest rate and other factors. It isn't easy figuring all the options.

"Simplicity rules," write Zvi Bodie and Rachelle Taqqu (finance professor and financial adviser, respectively) in "Risk Less and Prosper: Your Guide to Safer Investing." "Stay with plain vanilla. Cut through the plethora of choices by taking the time to clarify what it is you most want and need."

Among the most important choices is whether to buy an annuity that protects against inflation. It's a menu item that I like. Inflation erodes that value of savings over time and, even though inflation is relatively tame right now, it's a big risk all retirees face. The tradeoff: Initial payouts are lower than those from a standard contract.

There are two critical drawbacks to life or immediate annuities. One is that interest rates are so low at the moment. There's no real return on investment. The other is a long-standing issue with these annuities: The money is locked in. You definitely don't want to annuitize everything -- far from it.

To learn more about life annuities and the trade-offs, I recommend visiting the website Analyzenow.com, do some research at incomesolutions.com (based in Minneapolis) and look at Chapter 8 of "Risk Less and Prosper."

The other two major annuity categories are deferred annuities (fixed and variable) and equity-linked annuities. I'm wary of deferred annuities. They come with a death benefit, but fees are high in most cases and the death benefit is worth less than touted.

As for equity-linked annuities, my basic recommendation is this: Run. These are opaque securities that promise to limit the downside risk of owning stocks while allowing investors to share some of the upside. Simply put, the devil is in the fine print with this product, a classic case of the house always wins.

Chris Farrell is economics editor for "Marketplace Money." Send your questions to cfarrell@mpr.org.

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