Annuity ambiguity.

Annuity sales are soaring and it's easy to see why. These investment vehicles come with an insurance contract designed to protect you from losing your investment. They offer tax deferral and most of them guarantee fixed interest rates that are far above those of savings accounts, money markets, and certificates of deposit. And, well, let's face it most investors have come to learn that they don't have the intestinal fortitude for the stock market's gyrations.

So far so good, right? As with most everything, if it sounds too good to be true, it probably is. Take a closer look.

Annuities come in a variety of flavors. They may be variable or fixed, deferred or immediate, qualified or non-qualified and they are sold by insurance companies, brokers, bankers, and a whole host of financial services professionals. Variable annuities typically offer a variety of investment options, while fixed annuities simply offer a guaranteed interest rate for your investment. An immediate annuity will immediately begin paying you a guaranteed income stream for life, whereas a deferred annuity may be allowed to grow for many years until you begin taking distributions. Qualified annuities may allow tax deductible contributions, where non-qualified annuities are funded with after-tax investment dollars.

Regardless of the flavor combination you choose, your annuity earnings grow tax-deferred, meaning you won't pay taxes on those earnings until you begin making withdrawals. These withdrawals will be taxed as ordinary income and in general, distributions should not begin until you have reached the age of 59 , otherwise they are subject to a 10 percent penalty.

Not having to pay taxes on my investments every year sounds pretty nice as long as my tax bracket is lower when I begin making withdrawals than it is now. Note: tax rates are currently at historically low levels, so it might make sense to pay off the IRS today. In the case of non-qualified annuities which are funded with after-tax dollars, you might end up paying much more in taxes than you would have by investing in a mutual fund as capital gains rates may be substantially lower than ordinary income tax rates. Investing directly in equities or fixed income vehicles, as opposed to doing so inside of an annuity, will also allow you to benefit from tax loss harvesting whenever possible. You are not able to utilize this important tax savings strategy inside of an annuity.

Variable annuities tend to be expensive investment vehicles when you start reading the fine print. Many of these products have an annual fee of $30-35. They also charge mortality and risk expenses of 1 percent or more. And if that's not enough, the underlying investment options have their own expenses, bringing your grand total to 2 2.5 percent of your account balance annually.

These expenses are well defined in the contract prospectus, but the only fee you're likely to notice is the $30-35 annual fee. A plain old mutual fund is likely to cost you only 1 - 1.5 percent, comparatively.

Say you have invested your hard-earned money into an annuity and you decide it's time to get out. Again, go back and read your prospectus. You will find that most annuities come with a Contingent Deferred Sales Charge (CDSC), which is designed to keep your money in your account until the company has recouped its expenses and the commission has been paid to the broker or agent who sold it to you.

CDSC is a penalty for withdrawing (or even transferring) your money "early," and it often begins at 7 percent and is reduced by 1 percent each year. I have seen CDSC as high as 15 percent in some products. It is important to note that CDSC is generally linked to EACH deposit as opposed to just the initial deposit or contract anniversary date. This means that you may have owned a contract for 15 years but if you have made contributions every month for the past 15 years, there could still be a substantial penalty for withdrawing or transferring funds.

There certainly are cases where annuities make sense, but this is for a very small segment of the population. It is important to read the fine print before investing in any type of investment vehicle and annuities are no exception, despite their guarantees to protect your principal.