f you think about it, isn't it strange that annuities are considered insurance products?

Life insurance protects you against dying too young and annuities protect you against living too long. What they both have in common is that they are based on actuarial tables - how long you're expected to live given your age, gender and health. The price, annual payout and a portion of the expenses are based on those tables.

Annuities used to be the belt-and-suspenders approach to investing. You were guaranteed a specific rate of return before retirement then you received monthly income payments for life (and beyond, depending upon your payout option) after retirement. In general, annuities were not great investments - The interest rates were low and inflation cut into the value of your payments as the years passed by, making the real dollar payout worth less and less. Thankfully, times have changed and annuities can rightfully claim to be competitive investment vehicles on their own under certain circumstances.

Instead of "guaranteed everything," some annuities offer virtually no guarantees. In return, you get a shot at higher investment returns both during the accumulation phase (while the money grows untouched, usually until retirement) and during the payout phase (when you start to receive regular payments).

There is one nice tax advantage to annuities that makes them worth considering. Annuities act like a "wrapper" for whatever investments are held in them. Unless you're investing in annuities as part of your retirement plan, the money you put in is not tax deductible but all growth and income accumulates tax-deferred until you start to take the money out. You usually incur a 10 percent penalty if you take the money out before age 59 1/2, but withdrawals after that are only partially taxed because some of the money you take out is considered a return of principal.

There are two basic kinds of annuities - deferred (you put money in as a lump sum or on a regular basis and let it sit there), and immediate (you start receiving regular payments for the rest of your life or beyond). A further - and critical - distinction is between fixed and variable annuities. Fixed deferred annuities guarantee you a basic interest rate during the accumulation phase, although they often claim interest rates that are a few points above that guaranteed rate. For example, a frequent marketing technique for fixed deferred annuities is to "guarantee" (and advertise) a relatively high interest rate. In the fine print you discover that the guaranteed rate is only good for six months or a year.

Fixed immediate annuities offer a guaranteed monthly income during the payout phase. Fixed annuities usually guarantee a death benefit at least equal to the premiums paid in. At death, an annuity's payment schedule varies according to the payment option you choose - ranging from nothing to a reduced payment to your spouse for as long as he or she lives.

Variable annuities, in contrast, put the investment responsibility on you, the buyer. You choose the investments in the annuity; the growth in the deferred annuity is based on their performance, and the monthly payout in the immediate annuity varies according to their performance as well.

Variable annuities usually offer a number of investment options that are similar to mutual funds. These options can include money market funds, bonds, large company stock, small company stock and international stock funds, in addition to a fund that combines two of the categories such as bonds and large company stocks. The better variable annuities offer most or all of these options. Be careful, however. Some variable annuities still only offer you limited investment options, such as money market funds, bonds and large company stock funds from which to choose.

Although the investment performance is not guaranteed, deferred variable annuities do guarantee the return of all premiums paid in the event of death. As competition becomes fiercer, some annuities are now offering a death benefit equal to the highest value in the account for the previous five years and other special options. Variable annuities in the payout stage have death benefits based on the payout option you chose, just as with fixed annuities.

Variable annuities are also showing up as part of a relatively new kind of life insurance, variable life. In essence, variable life insurance combines term insurance with a variable annuity, and although there is a guaranteed death benefit, there is no guaranteed cash value because the company has transferred the investment risk to you. Just as with variable annuities, you have to pick the investment funds and your cash value depends upon their performance.

If annuities sound like complex investments, they are. That makes it all the more difficult to figure out their advantages and disadvantages and which kind (if any) is appropriate for your financial situation. Deferred annuities enjoy the advantage of having all growth and income sheltered from taxes until you start to take the money out. And unlike most tax-sheltered retirement plans, you are not required to start taking distributions at age 70 1/2 - or ever. Another advantage is that there's no limit in the amount you can invest, unlike retirement plans.

Perhaps most importantly, annuities guarantee that you will have a monthly income for the rest of your life, no matter how long you live. If you're married, you can choose the joint-and-survivor option that means your spouse will have a lifetime income even after your death (although the payment is usually reduced to 2/3 of the original amount). There are other payout options as well but these are the most advantageous.

Along with these substantial advantages come some hefty disadvantages to take into consideration. If you take the money out before age 59 1/2, you usually get hit with a penalty. The primary disadvantage, however, comes in the form of expenses - commissions and ongoing fees. Annuities are often sold via brochures that claim "no sales charges" and while that may be technically true, the commissions and fees are in there, just hidden. For example most annuities assess "termination fees" if you want to cash in your contract in the first few years (often up to seven years). These fees often start at 5 percent or more of the account's value during the first year and then gradually decline in the ensuing years.

There are also annual expenses to be considered. Variable annuities have higher expenses than fixed annuities because of the various sub-accounts, often running up to 3 percent or more. In fact, many experts say that you need to own a variable deferred annuity for at least 15 years to make it a more worthwhile investment than doing so on your own with, say, a mutual fund. That number is somewhat less for fixed annuities, but it's still something to consider. If you're talking about immediate variable annuities, higher expenses mean lower monthly checks to you.

The number of companies offering "commission-free" annuities is steadily increasing, and annuities do exist with expenses of less than 1 percent. This is a good trend that is expected to continue in the future as the annuity market becomes more competitive and buyers become more savvy about the actual cost of the financial products they buy.

Given all these complexities, there are some rules to follow to decide whether annuities are right for you.

There is a huge psychological benefit to purchasing an annuity, and that is knowing that no matter how long you live, you will receive a monthly income for the rest of your life. The tax shelter available may also make sense to you, depending upon your tax bracket and investment time horizon.

If you decide that annuities are for you, shop carefully, and make sure your investment choices are in line with your overall asset allocation. Annuities do have a place in many investment portfolios, but they also need to be kept in their place - behind retirement plans and as expense-free as possible.