Many prospective clients have said that they have already met with a financial planner or insurance agent and were encouraged to make the purchase of a large annuity for tax benefits. The reason the agent wants to sell an annuity is how lucrative the commissions are on these products.

Annuities may work in your portfolio but normally they won't unless you own shares in the company pushing them. The most common style is the tax deferred annuity. In the case of a deferred annuity, you pay up front or with a series of installments, and you don't have to pay taxes on the increase until you withdraw. You will then receive regular income.

Do you recognize this scenario? Retirement plans such as an IRA can postpone tax day until after your investments have compounded. This fact alone makes tax-deferred annuities redundant Why buy them, then? Except for some important exceptions, you normally should pass on annuities.

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Here is the case against annuities, as made by the Motley Fool, business magazines and certain Fee-Only investment advisors:

1. Tax-related arguments other than that mentioned above. Capital gains that you make in the market are taxed at a lower rate when you hold your stocks long enough before selling, currently a year. The IRS treats annuity payouts as ordinary income.

2. Most annuities charge too much in fees and commission. When you add everything in, you do not enjoy the same low fees over the years like you would through a Fee-Only planner or Vanguard-style index fund. Annuities also charge you for things like "mortality and expenses charges."

Don't even think about cashing the annuity out early - you may pay a surrender charge as high as seven percent.

Then there are management fees, just as with a mutual fund. Normally they will be lower but still more than those of an index fund. When it's all said and done, your annual fees may reach two percent - nearly twice what a Fee-Only planner would charge.

3. The insurance coverage that annuities offer isn't that great, etiher. They also don't work out very well as death benefits. Fortune says annuities are "an inefficient way to buy life insurance, and almost no one collects on it anyway."

4. To grow your investment, the annuity providers often use products producing less than stellar in yields. A fixed annuity means you are guaranteed a certain return, but then it's so low inflation could overwhelm the earnings..

With a variable annuity, you can decide to a limited extent how to invest your money. But it will have to be placed in what amounts to as an in-house mutual funds. Sounds a bit like the dealings of certain brokerages where not-so-objective planners direct you to their own dogs?

Another choice could be an equity-index annuities. You'll be guaranteed a return of several percent, but your upside is limited, too. If you're a long-term investor, why not invest in the funds yourself?

5. Annuities tie up your money so you can't invest it somewhere more profitable.

I According to the Motley Fool, annuities "are desirable only for those who:

* "Have contributed the maximum to their 401(k) plans and IRAs and desire further tax deferral on investment gains."

* "Prefer investing in mutual funds as opposed to individual securities.

* "Will keep the annuity for at least 15 to 20 years." But, let us add here at ElderAdo, that argument is rather irrelevant to most people who are retired or close to it.

* "Are in a 28 percent or higher income tax bracket today, but expect to be in a lower income tax bracket in retirement."

* "Don't need the annuity proceeds prior to age 59 1/2.

* "Are unconcerned that heirs must pay ordinary income taxes on any appreciation.

* "Desire a 'guaranteed' income for life in retirement."

The later argument can be very powerful and persuasive. Remember the tradeoff. When history repeats itself, the "guaranteed income" will be much smaller than the rewards of proper investing in the stock market.

The SEC is examining the marketing materials of the biggest underwriters of annuities, including, says Forbes, ING Golden American, American Skandia and Allianz Life. It quotes Paul Roye, director of the agency's Divsion of Investment Management: "The industry is on notice."

That says it all. If you feel you must buy an annuity, be certain that the person recommending it is not going to receive a commission. Boldly ask how he or she will benefit directly or indirectly from a sale, and watch out for the fees today and down the road.

RESOURCES

* Annuity Gratuity, Carrie Collidge, Forbes, Feb. 19, 2001.

* Annuities: What's to Like?, The Motley Fool, July 5, 1999.

* The Money Manager: Finally, a Warning about Annuities, Carolyn T. Greer, Fortune, July 5, 1999.

* The $6.4 Billion Ripoff, Barron's, March 27, 2000.

Roger Sorensen

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