Tax-deferred annuities come in two types: fixed and variable. Historically, fixed annuities have been pretty straightforward. You get a specified yield for the term of the annuity. Thus, it’s a simple matter of deciding whether the yield seems attractive compared to the alternatives, whether the issuing insurance company appears to be financially strong and whether you’re willing to lock up your money in the annuity structure until age 59½.
But picking among fixed annuities has grown more complicated, for two reasons. First, many annuities offer first-year teaser rates or other come-ons, which make it harder to compare one annuity with another.
Second, some insurers have been pushing a relatively new breed of fixed annuity known as an indexed annuity. These annuities offer returns that are pegged to a market index, such as the S&P 500-stock index, while offering downside protection.
Problem is, investors never get the index’s full annual total return. Instead, returns are based on the index with dividends excluded, plus the amount you can earn in any given year is often capped. On top of that, you typically face steep surrender charges if you cash out in the first 10 years or so. Those surrender charges are necessary because indexed annuities pay huge commissions to the salespeople involved, and the annuity needs to recoup that money from investors.