By Adam Carlat, Special to Independent Newsmedia

You may have heard of annuities – investment contracts in which an individual makes an up-front payment in return for a specified annual or monthly income in the future.

Perhaps you saw them pitched by a favorite celebrity in a television commercial, or maybe you were invited to a “free” event akin to those used to market time shares. Sadly, that’s not surprising: Annuities pay hefty commissions to those who sell them.

I’m not a fan; in fact, I’d rather not offer annuities, particularly when there are other solutions that could be better for a client. I earn my living based upon a fee for the advice and planning I provide for my clients, not from product commissions. Plus, in my opinion, there are better options.

Annuities are very complicated products, with enough important variables to make a juggler’s head spin. They often are marketed based on fear – mostly that the market could drop suddenly, as it did a few years ago, but also that the customer might run out of savings before he or she dies. In addition to regular income, they potentially offer modest investment growth with little or no risk. If that sounds too good to be true, it often is.

Two types of annuities

There are various types of annuities, but here are two:

Fixed-Indexed Annuities (FIAs) – formerly known as equity indexed annuities – offer higher yields based on stock market performance, with protection against market declines. However, it is common for those yields to be somewhat lower than expected due to the combination of caps on the amount of interest that can be earned and fee-related deductions. The challenge is in understanding how an indexed annuity works, as it is much more complex than a standard, fixed annuity.

Most individuals elect to purchase a guaranteed-income rider with an FIA. This means the initial investment grows by a predetermined amount every year. There is typically a fee for having an income rider.

The value from the income rider is different from the “contract value” and death benefit. (The contract value, or “cash value,” is the market-based amount the annuity pays if the client dies or decides to cash out, subject to fees and penalties.)  The investor can withdraw a certain percentage of the income-rider value monthly or annually once he or she begins making withdrawals. There is a limit to how much one can take out per year without penalty.

For fixed Annuities, on the other hand, returns are calculated at a specific percentage every month or year.

The flip side

But that’s only half the picture with annuities – the first half.

With these products, the account value typically begins decreasing once a client starts receiving payments. There are no guaranteed cost-of-living adjustments; if the recipient needs a bigger check, it likely will involve more penalties and fees.

If you’re seriously considering purchasing an annuity, ask yourself some questions:

• How important are the liquidity and flexibility of your assets? Will you ever need more than a small percentage of your money at one time?

• How much interest would you receive?

• How long before you would break even on your initial investment?

• Will the payouts be enough for your needs and lifestyle?

• What are the penalties and other ramifications of altering the terms or cashing out?

• Would you do as well or better by investing in a bond or CD?

• What is the death benefit?

When I have a client interested in an annuity, I explain what it truly offers, and we analyze how that would fit into his or her overall financial analysis and income needs. Typically, after I discuss the pros and cons, clients find that annuities won’t offer them the flexibility and growth opportunities they originally thought.

Please just always make sure an annuity fits into your plan and is in your best interest before making the decision to invest in one.

Editor’s note: Mr. Carlat is a Glendale-based financial adviser and Chartered Retirement Planning Counselor® with One2One Wealth Strategies. Questions? Call (623) 850-0016 or email Adam@121ws.com.