Writing about tax-deferred annuities creates tremendous possibilities for misunderstandings and misleading uses of the information. So let me start with a series of warnings. Much like the label on your prescription medicine, these warnings inform you that the product within is designed to be a benefit, but only if you take it as directed, and avoid using it under the wrong conditions.

Here's the warning label for these tax-deferred, variable annuities:

  • Purchase only through a reputable dealer, with expertise in these products.
  • Purchase only from an insurance company with a strong financial balance sheet.
  • Understand there is no official federal bailout fund for insurance companies -- only state funds that may "assess" other insurers in case of a company failure.
  • Get a written explanation of all fees and charges.
  • Use only if you understand "surrender charge period" and are sure you won't need access to your money before that period expires.
  • Understand the risk of loss, as well what is, and isn't, covered by guarantees.
  • Understand the difference between "withdrawals" and taking an "annuitized" stream of income.
  • Understand what happens to the balance of your account if you die before taking out all your money.

Now, having read the warning label on the package, there are some interesting annuity products available in the marketplace. And some of the most generous ones are starting to disappear, as insurance companies reassess their ability to provide the returns they have been promising.

A tax-deferred variable annuity is a contract with an insurance company that lets you invest money for tax-deferred growth in a choice of mutual fund sub-accounts, which carry additional fees.

The value of your tax-deferred account depends on your fund investment choices within the annuity. The risk is that you make a wrong choice of investments and lose money.

That's why the industry has come up with a so-called guaranteed minimum income (and withdrawal) benefit. These protect your retirement income from bad investment decisions, at a cost and with some strings attached.

The guaranteed minimum income benefit provides, at an additional cost, protection against a market decline in the cash value of the variable annuity. That is, the insurance company guarantees a growth rate of 5% or 6% annually on the amount from which you will be able to withdraw income in the future. That "protected withdrawal value" is guaranteed no matter what the investment performance of your fund sub-accounts.

For example, to use some big round numbers: If you invest $100,000 in this type of annuity, you could get a guaranteed 6% rate of growth on your "protected withdrawal base." At the end of one year, that base would be $106,000, even if your stock market investment choices fell to be worth only $80,000. Next year, you're guaranteed to earn 6% on that base of $106,000.

On the upside, you get to a chance to make significant gains. If your stock market investments are successful, your investment account could be worth more than that guaranteed withdrawal base.

You have access to that actual market value at any time, assuming you're past the period of surrender charges. But the best use of these products is to take a withdrawal of no more than 6% a year (or whatever the guaranteed rate), thus preserving that protected withdrawal value.

You have access to all your cash at any time, once you're past the surrender charges. But the idea is to keep it growing at this minimum guaranteed rate, and hope your investments someday total more than that guarantee.

And that's what has the insurance companies a little worried these days. Many insurers are reducing the guaranteed rate to 5%, or even 4%, and increasing the annual costs and fees within the annuity.

As with all investments, you must never be blinded by the obvious rewards without understanding the costs and the risks. Tax-deferred annuities are not "chicken money" investments because of their costs, complexity, lack of immediate liquidity and lack of outright federal guarantees of insurance products. But they are worth a second look for investment capital, before some of the best deals disappear. And that's the Savage Truth.

Terry Savage is an expert on personal finance and also appears as a commentator on national television on issues related to investing and the financial markets. Savage's personal finance column in the Chicago Sun-Times is nationally syndicated. She was the first woman trader on the Chicago Board Options Exchange and is a registered investment adviser for stocks and futures. Savage currently serves as a director of the Chicago Mercantile Exchange Corp.

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