Annuity Pros and Cons

The upside to an annuity, though, is that there aren't any contribution limits. With a nondeductible IRA, your 2005 contributions are limited to $4,000 a year, with an additional $500 allowed for folks age 50 and above. With an annuity, there are no limits. You can put in as much as you want each year. And you are not forced to start withdrawing from your annuity at age 70-and-a-half, as with an IRA. You can leave the money in your annuity as long as you like.

Sounds good so far, right? Don't get too excited, the catch is coming.

The High Cost of Living

OK, here's the catch.

Annuities are expensive, laden with a ton of fees. There are big upfront sales charges and back-end surrender charges, which linger around 7% if you withdraw the money too soon. In addition, there's mortality and expense charges to cover the risk the insurance company takes on to pay you lifetime income. And don't forget the administrative and annual records maintenance fees.

So all those fees could defeat the whole point of the tax deferral on your earnings. That's because the industry's average expense ratio hovers around 2.35%, according to Morningstar. Some plans could hit 3.5%. The average mutual fund, on the other hand, charges just 1.44%.

And remember, you owe ordinary income tax on your annuity withdrawals, which could be as high as 35%. If, instead, you had your money in mutual funds, you'd only owe the 15% capital gains tax on the earnings.

"People get overly focused on paying taxes vs. generating the highest after-tax return," says Robert Nestor, Principal in Vanguard's Retirement Resource Center, who says they talk people out of using annuities every day for just that reason.

But if you are still convinced that an annuity is right for you, check out products from low-fee investment houses such as Vanguard, Schwab and T. Rowe Price , which offer no-load, low-cost products.