Introduction

This is NO time to purchase annuities.

Annuities are high-fee, illiquid investments that make insurance companies a boatload of money. Does this sound too critical? Not really; don't get me wrong, there are investing situations that call for an annuity, but they are just few and far between.

Since the depths of the “Great Recession,” the insurance industry has capitalized on the fear most investors felt when the stock market swooned from September 2008 to March lows in 2009. You might recall that the market was down over 50% from its high. Fear can be a great motivator, but not when it comes to annuities. When fear grips investors, insurance sellers soothe them with words like “safe,” “guaranteed,” and “never worth less than your initial investment.” Insurance agents, brokers, and some financial advisors use a lot of hype to sell the products to unsuspecting, unsophisticated investors. Advertising for annuities bulked up every financial and nonfinancial publication. These musings came from the insurance industry touting annuities as the alternative to the risky stock market. Then, as now, annuities seem like the safety net investors are looking for; forget it!

Before you decide to invest your hard-earned dollars in an annuity, an investor should read the fine print. There are different types of annuities, with the majority being very complicated insurance policies that are difficult to decipher and may result in unintended outcomes. Any investor should understand what they are purchasing and should not buy these products with expectations of a great return. You may even find that you will not receive any return over time.

The following chapter could help you save hundreds of thousands of dollars, avoid making a lousy investment, and prevent the difficulty of reversing a very inappropriate and costly investment decision. Let's take a look at this arcane investment that uses slick ads to entice you and then issues you a 200-page tome to explain what you purchased.

If you have trouble falling asleep, begin reading an annuity contract and you will certainly pass out.

My experience with insurance products—and specifically, annuities—dates back to late 1988 as a result of my father's sudden death. As one of five children and the only one having experience in the financial markets, I was the logical choice to assist my mother in addressing the settlement of my dad's life insurance and guiding her financial future (she was 54 at the time). Shortly after my dad's death, my mother and I met with two very well presented insurance agents to review my dad's life insurance settlement and discuss the potential investment options and opportunities that the insurance company offered. The agents immediately tried to persuade my mother to purchase an annuity product. I asked them to leave their presentation and their shiny brochure and escorted them out. As a novice in their field, but having enough experience in the financial markets, I knew it was going to take some research (there wasn't any Google or Internet) and examination to evaluate their presentation. As I read through the reams of documentation that no layperson could comprehend, I noticed many embedded fees throughout the structures and realized that the sale of the product heavily benefited the agent and not my mother. However, we decided that it would be prudent to allocate a small portion of the life insurance proceeds into a fixed annuity and reluctantly purchased the product. As it turns out, the timing couldn't have been better. The fixed annuity at the time yielded close to 10% and was fixed for 20 years, outperforming the 20-year treasury during that time period. We benefited from purchasing an annuity at the beginning of a three-decade decline in interest rates and rode the bull market; even though we weren't making a market call or an interest rate prediction, we ended up being on the right side of the market for that portion of her assets.

Fast-forward 27 years, and the insurance industry has not changed much, but as most of the current and soon-to-be retirees know, interest rates certainly have dropped and the US equity markets are trading near their all-time highs. The insurance companies still market annuity products using shiny brochures and complicated documentation and claim to provide excessive above market guaranteed returns.

What Is an Annuity?

Annuities were originally developed in Roman times; A.D. 225—A Roman judge produced the first known mortality table for “annua,” which were lifetime stipends made once per year in exchange for a lump-sum payment (Marvin Feldman 2012).

An annuity is a contract between you and an insurance company that is designed to meet retirement and other long-range goals, under which you make a lump-sum payment or series of payments to an insurance company. In return, the insurer agrees to make periodic payments to you beginning immediately or at some future date (SEC.GOV n.d.).

Annuities typically offer tax-deferred growth of earnings and may include a death benefit that will pay your beneficiary a specified minimum amount, such as your total purchase payments. While tax is deferred on earnings growth, when withdrawals are taken from the annuity, gains are taxed at ordinary income rates and not capital gains rates. If you withdraw your money early from an annuity, you may pay substantial surrender charges to the insurance company, as well as tax penalties.

Here's how an annuity works: You make an investment in the annuity (give the insurance company an upfront lump sum), and it then makes payments to you on a future date or series of dates. The income you receive from an annuity can be paid out monthly, quarterly, annually, or even in a lump-sum payment. The sizes of your payments are determined by a variety of factors, including the length of your payment period. You can opt to receive payments for the rest of your life, or for a set number of years.

Annuities aren't one-size-fits-all panacea investments, and they are not too good to be true, even though too many are sold that way. Sometimes they work well when placed properly in a diversified portfolio, and fully understood for the contractual realities of the policy. So let's take a closer look at the different types and the reasons you might want to stay away from the annuity sellers.

What Are the Different Types of Annuities?

Annuities can come in many different shapes and forms, but generally are either fixed or variable. The payments can start immediately (an immediate annuity) or after some accrual period (a deferred annuity).

Many investors may choose to purchase an immediate annuity by making an upfront payment, which will then be paid out over your life. If you chose an immediate annuity, you begin to receive payments soon after you make your initial investment. For example, an investor might consider purchasing an immediate annuity when approaching retirement age. In the current interest rate environment, it does not make any financial sense to purchase an immediate annuity. An investor can get a similar return investing in AAA-rated US government securities and avoid the salespeople and the annual fees.

The deferred annuity can have both an upfront payment or be paid over time. With a deferred annuity, your money is invested for a period of time until you are ready to begin taking withdrawals, typically starting in retirement. The deferred annuity accumulates money over time while the immediate annuity pays income streams immediately. Deferred annuities can also be converted into immediate annuities when the owners decide that they want to start collecting payments.

The most effective way to use a deferred income annuity is to buy one with a small portion of your portfolio and then delay the income distribution to the distant future to ensure a stream of income. You may pay much less for the product and peace of mind.

Variable Annuities

The insurance industry defines variable annuities as offering flexibility, investment choices, and legacy protection to allow premiums to be invested in a limited number of subaccounts, similar to mutual funds. Typically, the investment choices are heavily fee-laden. The subaccounts may be invested in a broad investment class of stock funds, bond funds, or cash. The variable annuity may offer a guaranteed minimum return even if your investment choices underperform (additional fees apply to purchase that rider) (Money.cnn, 2013).

Variable annuities involve greater investment risks and can lose value. The typical investment is in the equity market. When choosing a variable annuity you as the investor make the decision on how to allocate your money. You have a choice of subaccounts offered within the annuity. The value of your account depends on the performance of the funds you choose. While a variable annuity has the benefit of tax-deferred growth, its annual expenses are likely to be much higher than the expenses on regular mutual funds—I would recommend investment in ordinary mutual funds, which would certainly be a better option.

Associated Risks

Variable annuities can and do lose money. There is no FDIC or bank guarantee on variable annuities. If you are looking for a place to save money with no risk of loss, consider fixed-return vehicles such as US Treasury notes and bonds, bank certificates of deposit, or money markets.

The insurance company's financial strength will affect its ability to pay added benefits such as a death benefit, guaranteed minimum income benefit, and long-term care benefits. If the insurance company fails, annuity owners may not receive all the benefits they were expecting. Since 2009, there have been many legislative reforms enacted to better protect investors from failing financial services companies, and financial firms' balance sheets have been strengthened significantly. However, it is still important to evaluate the providers' financial strength and remain wary of the possibility of a financial services firm to not meet its financial obligations.

As with all purchased insurance products, investors should question the reliability and financial strength of the insurance company and its ability to consistently make payments in the future—that is, the creditworthiness of the insurer should be evaluated.

Check the insurer's credit rating, a grade given by credit bureaus such as A.M. Best, Standard & Poor's, and Moody's that expresses the company's financial health. Each rating firm has its own grading scale. As a general rule, limit your options to insurers that receive either an A+ from A.M. Best or AA- or better from Moody's and S&P. You can find the ratings online or get them from your insurance agent. It is possible an investor could lose money if the insurance company you invested with goes bankrupt. So it is critical to purchase annuities only from insurance companies that you're confident will be in business when you retire. There are, however, state guaranty funds that protect annuity owners if an insurance company fails, but the coverage is limited and varies from state to state.

Other Risks Are Lack of Flexibility

An annuity is a long-term investment that requires a multiyear commitment. But an investor can never be certain about the future. Keeping financial flexibility and liquidity can be worth real money to an investor. Annuities lock you into a limited pool of investments. If your situation or plans change, or the investment climate changes, or annuity returns are mediocre, it is extremely difficult and costly to cash out and switch to a better or more appropriate investment.

Equity index annuities can provide guaranteed minimum interest and beneficiary protection. Equity indexed annuities contain features of both fixed and variable annuities. Potential for additional growth is linked to the return of an index like the S&P 500. Most of the insurance companies will typically cap your return, so in an extreme up market year, the investors' upside returns are limited.

Following is a brief example of our new client Fred's (76 years old) previous purchase of equity indexed annuity and fee structure associated with the unwind.

In the fall of 2009, Fred purchased a product called Group Flexible Premium Deferred Annuity. When I questioned as to why he purchased the equity linked annuity, he told me it offered full S&P equity exposure and that the salesman gave him a 10% premium bonus when signing the contract. The product carried a 3.5% annualized cap rate with a 120% participation rate, which meant that he was taking outsized risk with limited upside reward. Additionally, the product carried surrender charges of 18% in year 1, reducing 2% per year through year 9! This investment offered very little liquidity, and in order to get his money out without penalties he would have needed to wait 10 years! Although the product with the bonus looked attractive on the surface, it offered Fred no ability to either capture gains or provide liquidity.

Variable Annuity Riders

Investor fear and greed drive insurance sellers. A few short years ago, several major insurance companies promoted getting a minimum guaranteed income for life, catapulting investors into pouring over $1.5 trillion into variable annuities (Money.cnn 2013). Driving the sales were buyers attracted by the living benefit rider, an optional feature ensuring that you can draw a base income from your investments regardless of how the markets perform or whether you drain your account.

Before the 2008–2009 financial crisis, annuity riders sometimes guaranteed returns over 8% (much of this actually is a return of your own dollars) with annual withdrawals of 7% and investors rushed into these insurance products seeing them as a guarantee with limited investment risk. However, over the past few years, most of the insurance companies selling these products had to scale back the guarantees while raising fees on new products and reducing investment choices and allocations.

A few companies even offered to buy out current customers' contracts and cancel their riders because the riders were too expensive to the insurance companies (great deals for the policy holder and bad deal for the insurers). Why would they do this? Well as interest rates collapsed and people were living longer the ability for insurers to guarantee their contractual commitments fell and left them with a questionable ability to meet future payment streams.

A lot of insurance companies got hurt and needed to restructure the terms of their contracts. If you already have a variable annuity you should review your contract, your current account value and the potential changes in terms. Many of the insurance terms are changing or have already changed to protect the insurance companies, limiting investment choices, lowering minimum returns and income guarantees and of course raising fees. Sometimes insurance companies screw up and misprice their products; savvy investors from time to time may have an opportunity to get a good deal.

There are now instances where the insurance companies need to restructure clients' long-term care policies due to inappropriate introductory pricing. The big insurance companies have the ability to petition their state insurance boards and ask for rate adjustments and subsequently apply policy payment increases. The odds are in the insurance companies' favor if they screw up a product as their lobby is very powerful and has the ability to force and make change to insurance contracts. This is not a fair and level playing field for the novice investor.

Here is an example of more structural changes to annuities as insurance companies continue to revamp their products:

Jackson National unveils tiered pricing for variable annuities (Mercado 2014).

A new pricing plan for Jackson National Life Insurance Co.'s popular variable annuity living benefit riders is scheduled to take effect starting Monday, September 15, 2014. Jackson will apply a five-tiered pricing scheme for single life versions of its LifeGuard Freedom Flex and LifeGuard Freedom 6 Net guaranteed minimum withdrawal benefit contracts.

“It's a continuation of our philosophy of building variable annuity products,” said Greg Cicotte, president of Jackson National Life Distributors. “We try to give advisors options to be able to customize the product for each individual.” The five tiers are meant to enable clients to choose a variable annuity based on what means most to them: higher withdrawals or lower cost.

Two components to understanding the tiers are income the client will get versus the cost, according to a June 11, 2014 filing Jackson made with the Securities and Exchange Commission.

First there's a level of income. Lower tiers offer less guaranteed income at a lower cost.

Jackson's move is one that permits the wildly popular variable annuity seller to mitigate flows into its contracts without calling for an outright ban on 1035 exchanges into Jackson contracts (more on 1035 exchanges on page 162).

Advisors might remember that last October the company decided to temporarily block transfers into its variable annuities, a repeat of a move it announced in late 2012. Effectively, such moves halt transfers for the remainder of the year.

With the new structure, however, Jackson can slow transfers and sales without rattling the reps who sell its contracts.

Is there any benefit to the investor? Not really, given level 5 sales being temporarily halted clients can still choose to purchase the slightly-cheaper and slightly less rich level 4 version of the riders. This type of variable annuity continues to raise concerns with the regulators.

So why have five tiers? In my view, it provides more room for confusion, hidden fees, and sales commission.

Investors need to know what to expect when purchasing an annuity.

Many unsuspecting clients purchased annuities from unscrupulous insurance sellers during the 2008–2009 downturn, preying on the investor fear and offering guaranteed returns. Let's take a real-life example; one of our 2011 clients, Maria, was sold not one but three annuities by a financial advisor/salesperson who regards the sales of multiple annuities and placing them in an IRA as suitable for this 46-year-old. Not that all advisors/salespersons fall into the same category but when we researched this one on the FINRA site we found details of improprieties (see the following recap). The reason for selling various annuities is all about sales credits and the payout associated with the sale of another annuity; having three annuities staggered enables the salesperson to benefit greatly while making it more difficult for an investor to unwind their investment in a liquidity event.

It is pretty easy nowadays to research just about anyone. Thoroughly check out your broker using FINRA Broker Check to learn whether your broker is licensed and has a history of complaints. When I searched their site I found compromising details about the salesman who sold the above annuities to Maria. This information is entered by the reporting source (broker, firm, or regulator). If Maria was an educated investor she certainly would not have purchased the annuity knowing the agent had numerous complaints. Simply having this many blemishes on your record is a red flag and cause for concern.

As a financial advisor we come in contact with many retirees who have been misguided and some by their local trusted Bank. Last year I met with a retired couple who went to their local US Bank branch where they knew the tellers by their first names and were very comfortable with them.

As often the case a teller suggested that they meet with the bank's investment brokers. Discussions and an evaluation ensued, and the bank investment specialist sold them a variable annuity. They invested more than $625,000. The annuity promised to generate lifetime income payments.

Of course the retirees wanted to make the most amount of interest they could.

What they didn't fully understand was that the variable annuities came with a steep annual charge: about 4% of the amount invested. That came to more than $25,000, annually—enough to buy a new car every year. What's more, if they needed to tap the money right away, there would be a 7% surrender charge, or $43,750 taken from their principal.

Many local banks claim that these investments are appropriate and that fees were disclosed, and that the sales are completed after months of consultations. But the retirees now question whether they were given financial advice that was truly in their best interests.

Like many consumers, they say they didn't realize that their broker wasn't required to follow the most stringent requirement for financial professionals, known as the fiduciary standard. It amounts to this: Providing advice that is always 100% in the consumer's interest.

Illiquidity, or the Lack of Being Able to Get to Your Money

Annuities offer unique features and benefits not found in traditional or classic investments like stocks, mutual funds, and bonds. In addition, the annuity contract is more restrictive.

However, one of my biggest peeves across the product is the lack of liquidity. Annuities require a specific investment period. Many minimums are 7 years and some are blindingly longer before investors can start receiving income from the account. During the accumulation phase, the annuity contract may allow for an annual 10% withdrawal of original principal, however if the investor really needs to tap into the funds and withdraw more than 10% the penalties are severe.

Additionally, many annuities offer other insurance type products including death benefits; some of the variable annuities noted earlier offer built-in riders for insurance. The contract may include a death benefit (“basic life insurance”) with a guarantee to pass money to a beneficiary in a lump sum or overtime. However, like all riders in annuities, the investor must pay for the additional insurance. The alternative would be to buy a much cheaper life insurance policy outside of the annuity.

Evaluation of Returns: Investment Options inside of Variable Annuities

Though “guaranteed,” a variable annuities return may be much less than traditional investments like stocks and bonds over time. Prior to entering a multiyear contract, investors should compare other investment alternatives. For example, fixed annuities provide guaranteed interest, but the insurance company may reset the rate annually, perhaps below what investors can get from investing on their own in government, municipal, or corporate bonds or other plain-vanilla fixed rate investments.

The account values of variable annuities generally follow the performance of the subaccounts' underlying investments—bonds, mutual funds, stocks, or money markets. However management fees, operating expenses and other charges that are associated with variable annuities can reduce returns relative to directly investing over time. In addition each subaccount manager should be evaluated on performance fees similar to an evaluation of any other pooled investment of mutual fund.

Let's take a look at the returns of traditional indexed annuities; in many cases the return is calculated from a benchmark rate of return minus a fee that can include a margin, a spread or an administrative fee. For example, if the benchmark index rose 8% and the fee was 3%, you would receive a 5% rate of return. A few percentage points over time can make a significant difference in an investor's overall return. Let's compare $100,000 invested in the S&P 500 Index versus buying a hypothetical annuity for 30 years ended December 31, 2013. The annuity offers 100% participation to the S&P 500 Index with an annual 3% minimum guaranteed rate of return and cap of 10%:

Additionally, some of the annuities tie their performance to an index that does not include dividends or their reinvestment; therefore, although very obvious, the annuities return will be significantly lower than an index with dividends reinvested over time. A number of companies promote “S&P-like” returns without including dividend. This type of marketing is deceiving the investor who thinks he is purchasing an investment that is matching the benchmark return, and they will most likely not ask if dividends will be included as part of their investment. Note this occurred in the previous Jackson National product sold to our client Fred.

Fee and Charges

Annuities generally come with more protections and guarantees than other investment vehicles, such as mutual funds, but at a cost. Annual expenses for variable annuities can be much higher than the expenses for a similar portfolio of mutual funds. Annuities often carry high, ongoing fees when compared to traditional investments such as mutual funds.

Options If You Already Own an Annuity

Should I exchange my current annuity for a new one, known as the 1035 exchange?

Be especially cautious if an annuity salesperson suggests you should exchange your existing annuity for a new annuity. This may be the only way the salesperson can generate additional fees. Read all the sales documents yourself and make sure you are aware of every potential fee. Never rely on the salesperson's explanation alone. You should ask for an annuity cost comparison report where your agent should be able to clearly document the current contract's expenses and surrender charges versus the new contract costs. You should exchange your annuity only when it is better for you and not better for the person selling the new annuity contract. Exchanges are known as 1035 swaps, after the section of the IRS code that regulates them. An insurance salesperson may tell you a 1035 swap is a great deal, because it allows you to get the features of a new annuity without incurring any taxes. What you might not be told is that the exchange earns a fat sales commission for the insurance agent.

What's more, by moving into a new annuity, you will start a new surrender period. For example, say you have owned an annuity for 10 years. You probably could close out your account without paying a surrender charge. But if you swap that annuity for a new one, you may be hit with a surrender charge.

The 1035 swap is not all negative; one appealing aspect is the tax-deferred growth of the funds in accumulation. Money that you invest in an annuity grows tax-deferred. When you eventually make withdrawals, the amount you contributed to the annuity is not taxed, but your earnings are taxed at your regular income tax rate.

But again depending on your tax status, an additional negative is that the gains in an annuity portfolio are taxed as ordinary income, for most investors the long-term capital gains tax rate is lower. Also, unlike traditional life insurance payouts the gains on the death benefit payouts may be fully taxable. Of course, with any structured investment you should consult with your financial and tax advisor before making any long-term decision—particularly with the purchase of an annuity, which imposes harsh penalties for any contract changes or withdrawals.

When Should You Consider Using an Annuity?

Typically, you should consider an annuity only after you have maxed out other tax-advantaged retirement investment vehicles, such as 401(k) plans and IRAs. One of the biggest advantages as a result of the very dated 1986 tax laws, an investment in an annuity allows you to put away a large amount of cash and defer paying taxes. Unlike other tax-deferred retirement accounts such as 401(k)s and IRAs, there is no annual contribution limit for an annuity, which allows you to put away more money for retirement, and is particularly useful for those that are closest to retirement age and need to catch up their savings.

If you have additional money to set aside for retirement, an annuity's tax-free growth may make sense—especially if you are in a high-income tax bracket today. All the money you invest compounds year after year without any tax bill from Uncle Sam. That ability to keep every dollar invested and working for you can be a big advantage over taxable investments. When you cash out, you can choose to take a lump-sum payment from your annuity, but many retirees prefer to set up guaranteed payments for a specific length of time or the rest of your life, providing a steady stream of income. Additionally, the annuity can serve as a complement to other retirement income sources, such as Social Security and pension plans.

Sometimes annuities are sold to unsuspecting investors inside of IRA or other retirement vehicle. It is probably not a good idea to hold an annuity inside of an IRA. Since one of the main advantages of an annuity is that your money grows tax-deferred, it makes little sense to hold one in an account like an IRA, which is already tax-deferred. It's a little like wearing a raincoat indoors or a belt and suspenders. There are a few exceptions. If you're retired or very close to retiring and you feel you need more guaranteed income than Social Security will provide, it can make sense to use a portion of your 401(k) or IRA money to buy an immediate annuity that will pay income for life.

Recent Developments with Annuities

The following excerpt from Investment News says that now the Treasury and the IRS are onboard saying it is OK to put annuities in your 401(k)! This is absurd! Read on:

Investment News (Schoeff 2014)

The Treasury Department and IRS approval of the use of annuities in target date funds in 401(k) plans, including as a default investment, will make lifetime-income features more popular and help ensure that droves of baby boomers don't outlive their nest egg, industry officials and experts say.

The Department of Treasury released guidance for plan sponsors on how they can expand the use of deferred-income annuities, providing a special rule that allows defined-contribution plans to offer target date funds that include annuities among their assets.

Treasury will permit deferred annuities to be offered at prices that vary with a participant's age. That means discrimination rules would no longer apply if the plan includes both people who are younger than the age limit for the annuity and those who qualify for the annuity.

The department also will allow retirement plan participants to mix annuities with other savings vehicles.

“Instead of having to devote all of their account balance to annuities, employees use a portion of their savings to purchase guaranteed income for life while retaining other savings in other investments,” Treasury said in a statement.

The agencies' moves will make plan sponsors more comfortable adding retirement-income guarantees, said Jason Roberts, chief executive of the Pension Resource Institute. This does not seem logical.

“It's making it like target date on steroids,” she said. “The idea of guaranteed income for life is very powerful. Something needed to be done to enable 401(k)s to do their jobs. I've seen a lot of mediocre retirement plans out there.” This is scary, potentially packing junk into 401k plans. Ms. Prince supports Treasury's effort to boost retirement security, but said that while the new TDF rules “sound good on paper,” it remains to be seen whether they will be effective. “There are a lot of unanswered questions,” she said. “It depends on how [a plan] is constructed, how well it's explained to participants and the fees.”

Is this really a good thing, having fee-laden annuity products inside of a 401(k) and available in other company retirement plans? Most investors don't have a clue as to what basic mutual funds to choose in their plans, let alone a complicated insurance product. Again, given today's rate structure, it would be difficult for someone to get any return buying a fixed annuity.

A few years back, I identified a relatively sound solution that provides inflation protection and is safer than an annuity. Buy US Series I Bonds annually. Series I bonds can be purchased free using US Treasury Direct.

The current rate set as of May 1 is zero, as of November 1, 2014 it was 1.48%. The next rate will be reset on November 1, 2015.

Savings Bonds: Little-Known Good Deal

Tired of low interest rates? Money market funds and one-year bank certificates of deposit pay less than 1%. Pretty lame.

But the much-ignored US savings bond Series I (meaning it tracks inflation) is a pretty good antidote to the low-rate blues. Because the bond is backed by Washington, it is very safe.

The current 30-year savings bond pays 3.06% over six months. That's comparable to the annual yield on a 30-year Treasury, which doesn't have the virtue of adjusting its rate to follow the Consumer Price Index, as the savings bond does. The government issues an inflation-tracking bond, called a Treasury Inflation-Protected Security, or TIPS. But due to strong demand, the 30-year TIPS yields less than the comparable savings bond.

Savings bonds are far less popular than they used to be. People bought $1.5 billion in savings bonds during 2011, about a fourth of the amount sold 10 years before. Part of the reason may be that you can trade a standard Treasury bond on the open market, any time you like. Savings bonds can only be redeemed from the US Treasury after 12 months, and if you do so early (within five years), you pay a penalty by forfeiting the most recent three months' interest.

Another factor is that, four years ago, the government reduced the maximum yearly purchase to $10,000 from $30,000. The $10k annual restriction makes it difficult for the high-net-worth investors to make a difference in their portfolio; however, duplicating an investment annually for a husband and wife can build a portfolio to over $250,000 over a 10-year period. One bond costs a mere $25, and is sold at face value. Maybe savings bonds' withered appeal also stems from their stodgy image: First issued during the Great Depression, they for decades were a favorite gift to grandchildren, about as welcome as a new pair of socks.

But so what? Many investors are missing out on a great opportunity. There are other types of savings bonds that pay far less than the inflation-linked kind, such as the Series EE (0.6%). The Series I variety is a no-brainer purchase.

Rates for I bonds change each six months, reset on May 1 and Nov. 1. So the 3.06% earnings rate for I bonds bought from November 2011 through April 2012 also will apply for the succeeding six months after the issue date.

Series I bonds were introduced in 1998. Interest accrues monthly and compounds semiannually for 30 years, and the interest is tax-deferred until the bond is redeemed

You can buy, manage, and redeem I Bonds online by setting up an account with the government's Web purchasing service, called TreasuryDirect. Starting this year, the bonds are no longer issued in paper form, a move to save printing costs. TreasuryDirect account owners may convert their Series E, EE, and I paper savings bonds to electronic securities. (Exception: You can still get paper bonds if they are purchased using part or all of one's tax refund.) For more information on this feature, visit www.irs.gov.

The bonds are exempt from state and local income tax. Plus, there are additional tax benefits when the interest is used for education expenses. Qualified taxpayers can exclude earned interest from their gross income. Eligible education expenses include tuition and fees.

In closing this chapter, I will conclude with why you don't need an annuity, how to protect yourself, and a few questions to ask yourself and the annuity salesperson. In summary, you don't need an annuity:

1. If you can manage the money yourself or have hired a suitable professional. Annuities should only be owned for their contractual guarantees, so if you are adept at managing your own money and feel comfortable performing that task, then you should not deviate from that plan. If you have an adviser who has proven themselves to be really good at managing your money, then consider yourself fortunate and stay the course with that professional.
2. If you don't need additional lifetime income. As noted earlier, annuities were created in Roman times for pension-type lifetime income guarantee. Even though variable and indexed annuities can be unbelievable complex and unfortunately represent the vast majority of annuities sold each year, the primary reason that most people should own an annuity is to solve for longevity risk (i.e., outliving your money). If you don't see yourself needing additional income guarantees for the rest of your life and you are pretty good at managing your own money, then you probably have no need for an annuity.
3. If you want equity market growth. Annuities aren't growth products, regardless of the brokers' hypothetical growth dreams that are overly promoted. Even the best no-load variable annuities have limited investment choices and restrictions on moving the money between separate accounts (i.e., mutual funds). Indexed annuities were designed to compete with CDs, and their historical returns noted earlier reflect the realistic return percentages, and also noted today's interest rates are ridiculously low to purchase fixed annuities. Load variable annuities have limitations and restrictions from an investment standpoint, and their typical high fees severely eat into any annual returns.
4. If you want everything packed into one product. Riders are attached benefits that you can add (with an annual fee for the life of the contract) to some annuity policies to try to solve for solutions like lifetime income, legacy, or long-term care. Insurance carriers and their agents love to promote these one-size-fits-all product scenarios, but you are best served by solving for one solution at a time with any annuity strategy. In most cases, the contractual guarantees are higher when you implement a single focus solution. The more isn't the merrier with annuities.
5. If you are only being shown one product from one insurance carrier. Because annuities should be owned for their contractual guarantees, you should always shop numerous carriers for the solution you are looking to solve for. It is a good practice to shop around just like you would for any product. It is also important to remember that annuity guarantees are only as good as the company backing them up, so do your homework on the safety of the carrier.

   Annuities have some significant drawbacks, and brokers recommending variable annuities must explain to you the important facts—including liquidity issues where you must be willing to sock away the money for years, potential surrender charges and other fees, as well tax penalties for withdrawal, mortality and expense charges, administrative charges, investment advisory fees, and, of course, market risk. As already noted, if you purchase a variable annuity, ongoing investment management and other fees often amount to close to 4% a year. These fee structures can be complex and unclear. Insurance agents and others who sell them may tout the positive features and downplay the drawbacks, so make sure that you ask a lot of questions and carefully review the annuity plan first. Before you invest, you should compare their fee structure with regular no-load mutual funds, which levy no sales commission or surrender charge and impose average annual expenses of less than 0.5% (for index funds) or about 1.0% (actively managed funds), and determine whether you might be better off going that route on your own.

   If the sales pitch sounds too good to be true, then write down in detail exactly how you think the annuity being proposed is going to work according to what the agent said. Then sign and date that list, and have the agent sign and date it as well so you can have the agent fully endorse the recommendation. This is just an effective and simple idea to fully flush out the contractual realities of the policy. If you are getting pressured into buying or a red flag is raised for any reason, then it's probably best to move on. Ask the salesperson: How long will my money be tied up? Will you be paid a commission or receive other compensation for selling the annuity? How much? What are the risks my investment could decrease in value?

   And finally, ask yourself, am I already contributing the maximum to my 401(k) plan and other tax-deferred retirement plans? Do I have a long-term investment objective? Am I going to need the money before the surrender period ends? Will I need the money before 59½? Do I fully understand how the variable annuity works, the benefits it provides, and the charges I have to pay? Have I read and understood the prospectus? Are there special features provided such as added long-term care insurance that I don't need? Have I shopped around and compared the features of variable annuities, such as sales load and other fees and expenses? Do I understand the effect annuity payments could have on my tax status? If I am purchasing a variable annuity within an IRA, do I understand that IRAs already provide tax-deferred savings? Am I being pressured into making a quick purchase?

Hopefully, the chapter was able to point out the strengths and many weaknesses of annuities. On the surface, annuities seem like a safe asset allocation and, as noted, prey on investors' fears during market volatility. However, as mentioned throughout this chapter, there are many drawbacks that aren't obvious to the average investor. Be sure to thoroughly research and ask many questions before purchasing an annuity.