Variable Annuities: Beware

Don't invest in variable annuities without understanding them. Though they're technically insurance products, they're often promoted as investments - specifically, retirement savings vehicles with returns that "vary" according to how you invest the assets. Here are some things to know:

• Investments in variable annuities do grow tax-deferred. But tax rates are low these days, and the money you ultimately withdraw will be taxed at income rates, not the lower rates for dividends and long-term capital gains. Also, you can get tax-deferred growth from 401(k) plans or traditional IRAs, possibly along with a tax deduction.

• When you buy into an annuity, be prepared to stick it out, or get stuck. Try to withdraw your money within the first few years and you may face "surrender" fees of 7 percent or more. On $100,000, that could total $7,000. Also, withdrawing before you turn 59 1/2 will generally result in hefty penalties.

• Annual fees for variable annuities are typically between 2 percent and 3 percent. If your annuity is worth $100,000 and you're paying 2.5 percent in fees, you'll be forking over $2,500 per year. Ouch!

• The insurance component (the so-called "death benefit") may not be as exciting as it seems. (For one thing, you must be dead to receive it.) Usually, your heirs will receive (1) what you put into the annuity, (2) its current value, or (3) a "stepped-up benefit" based on the value of the account on a certain date - whichever is greater. If that value was locked in when the market was at record highs and you die before the market recovers, then the insurance pays off for your family. Otherwise, the feature makes more money for the insurance company than for you.

Fortunately, there are some companies, such as Vanguard (877-662-7447) and T. Rowe Price (800-225-5132), offering low-cost annuities without surrender charges. For most people, it's best to max out 401(k) plans and IRAs before thinking about variable annuities. Fixed annuities are also often better deals. Learn more at www.sec.gov/investor/ pubs/varannty.htm and at www.fool.com/ retirement.htm.