(MONEY Magazine) – If annuities were Isuzus, they would open hyperbolic new vistas to the little cars' mendacious TV pitchman. At first glance, single-premium deferred annuities seem to deliver everything risk-averse investors crave: an attractive fixed rate of return, recently as high as 10%; a guarantee that your investment will not be zapped by plunging stock or bond prices; and a shelter in which every dollar of your earnings compounds free of taxes until you make withdrawals. Trumpeting these advantages, an army of insurance agents, financial planners and stock brokers sold an estimated $10.4 billion of single-premium deferred annuities last year. Some companies reported sales increases of more than 60%. What they are selling is a vessel into which you pour one payment of anywhere from $1,000 to $500,000 or more for retirement. There is no immediate payout and no definite date for payouts to start. You decide years later whether to use the money and its earnings for lifetime annuity income or to withdraw it all at once. (For a quick fix on annuity jargon, see page 133.) Clearly, their stability of principal and fixed rates of return give annuities an edge over crash-prone stocks and mutual funds these days. But some of the highly touted guarantees are about as ironclad as campaign promises. Those secure high rates of return, for example, typically vanish after one year. And while marketing brochures stress that your annuity account's balance won't drop if the stock or bond market does, the sales literature glosses over the stiff tax penalties and early-withdrawal fees that can drain your assets as severely as another Wall Street crash. Furthermore, some annuities generate their touted high rates from junk bonds. Warns Joseph Belth, an insurance professor at Indiana University: ''You've got to approach these investments with a healthy dose of skepticism.'' Annuities, like Individual Retirement Accounts, are often pitched as tax shelters. But, in fact, both work best as ways of stockpiling retirement money. The difference is that you are limited to yearly contributions of $2,000 to your IRA, while there is practically no limit on how much you can sock away in an annuity. The ideal candidate for an annuity, therefore, is someone who wants to put a lot of money aside as soon as possible and be able to use it years later to grind out monthly income. On the other hand, various penalties and restrictions make annuities ill suited to investors who are just looking to lock in a high rate of return. The tax-sheltered earnings can boost your results, but don't confuse a tax-sheltered rate of return with the tax-free return on municipal bonds. Munis currently pay a 7.8% after-tax return. But since you must eventually pay taxes on the earnings in an annuity, the after- tax return on a plan paying 8% for 10 years could fall as low as 6.3% -- only half a percentage point more than a comparable taxable investment, such as a bank CD. To reap even this modest reward of tax deferral, you must not dip into your investment before age 59 1/2. If you are younger, a 10% penalty on all your earnings, on top of regular income taxes, will ordinarily wipe out most or all of the benefit of tax deferral. Cautions Jack Haraburda, a marketing vice president of Merrill Lynch's insurance subsidiary: ''These are not liquid investments.'' The theory behind single-premium annuities is simple and reassuring. An insurance company invests your money in its portfolio of bonds, mortgages, stocks and real estate and assumes full market risk. You are guaranteed a set rate of return for a specific period, usually one year but sometimes as long as five years. After that, the company declares a new interest rate each year. When you are ready to start drawing on the account, you can postpone the tax bite by annuitizing -- that is, converting the balance into a monthly income stream. At that point, the portion of payout representing the growth of your original investment is taxable. Annuities bristle with hidden and undisclosed costs that make comparison shopping a bit like a trip through a minefield. The tallest tariffs are company-imposed surrender charges for early withdrawal, which usually kick in if you tap more than 10% of your account value in a year. Typically, these charges start at 6% to 8% for the first year or two and then decline by a point or so each year until they disappear. But some companies' penalties are absolutely draconian. Guarantee Security Life of Jacksonville hits investors with surrender charges as high as 15%, for example, and the widely sold annuities of Federal Kemper Life in Long Grove, Ill. have a surrender charge of 6% that never disappears. By contrast, withdrawals from annuities sold through the mail by USAA Life (800-531-8000) are subject to only a 4% charge, plus $25, in the first three years. After that, you pay just $25 for each withdrawal.

Sales brochures seldom reveal how seriously taxes and surrender charges can erode the return on your investment. A bar chart in the Keyannuity brochure of Keystone Provident Life of Boston shows that $100,000 invested in its annuity and earning 8.5% for 10 years would grow to $226,098, while the same amount in a taxable investment yielding 8.5% would be worth $181,122. The annuity is a clear winner -- except there's no way you could put your hands on the full $226,098. Income tax at 28% would siphon off $35,307. If you were under 59 1/ 2, the 10% tax penalty would take another $12,610. That leaves $178,181 -- or less than you would net from the taxable investment. For greater flexibility in cashing out, seek an annuity with a more favorable escape clause called a bailout provision. Some insurers agree to waive surrender fees if the renewal yield falls one percentage point or more below the rate initially guaranteed; others give you the right to exit without penalty when the initial guarantee expires. Unless you are certain you won't have to tap your investment, avoid companies such as Allied Life of Des Moines and Western-Southern Life in Cincinnati, which have high surrender charges and no bailout provision. This unfortunate combination greatly inhibits access to your money in an emergency and reduces your ability to maneuver for a better deal from another insurer. Without exit penalties to worry about, you can switch profitably to a competitor's annuity paying a higher rate. Note that you can also escape taxes through something called a 1035 exchange, which is similar to a tax-free rollover of an IRA. Even if you don't have to pull out early, your return in an annuity can suffer from sales charges and administrative expenses. While these charges are seldom collected up front, agents nevertheless earn commissions of 3% to 7% of your original investment -- and some insurers pay them as much as 10%. The money comes from the proceeds of high surrender fees or from your portfolio earnings. Before you buy an annuity, don't be embarrassed to ask the agent what commission he will earn on the sale. If he balks, go to another agent. At least one company, USAA Life of San Antonio, operates without a sales force and offers true no-load annuities. Commissions can influence which annuity a salesman recommends. For example, a financial planner who stands to earn $9,000 selling a $100,000 Guarantee Security single-premium annuity or a mere $2,500 for pushing a John Hancock annuity might lean toward the one with the higher reward. And brokerage houses such as Merrill Lynch, Dean Witter and Prudential-Bache entice their brokers to push the annuities of affiliated insurance companies by offering slightly higher commissions for selling the house brand. Insurance companies also lure salesmen with free travel and vacation packages. For example, agents who unload $3 million worth of annuities for Sun Life of America this year will win a trip to Switzerland. Do such incentives color recommendations? ''There's no question in my mind this affects the judgment of financial planners and insurance agents,'' says Tim Medley, a fee-and-commission financial planner in Jackson, Miss. + The biggest challenge for shoppers is choosing an annuity that will consistently pay a competitive interest rate. All annuities guarantee a rate for the life of the deal, but it is a trifling 3% to 5%. To sell their plans today, insurers are promoting one-year rates of 8% to 10.9%. A few are guaranteeing rates for five years, but they run as low as 6.75%. When the initially guaranteed rate expires, your renewal rate will be whatever the insurer decrees. In setting it, most companies look to the current and forecast yields on their investment portfolio and rival instruments such as CDs. ''But companies also know they don't necessarily have to be competitive in renewals,'' says Glenn Daily, an insurance analyst at Seidman Financial Services, a planning firm in New York City. ''Some investors go into a daze and don't keep track of their rates.'' That may explain why some insurers are slow to raise their yields when interest rates are rising. New England Life, for example, renewed its annuities at 6.25% in early 1979, when CDs were paying 11%. Two years later, CDs had jumped to 15.5%, but New England's renewal rates remained unchanged. The company now acknowledges that the annuity, since discontinued, was poorly designed to keep up with steeply climbing interest rates. To avoid getting trapped in an annuity with a lagging return, ask the salesman for a history of the company's rate renewals. A competent salesman who regularly deals with one or two different companies should be able to produce at least a partial record. In 1984, for example, Transamerica Occidental Life guaranteed new buyers a 10.7% one-year rate. Renewals have not dropped below 9.7%. Competitive renewal rates can sometimes tell you more about an annuity than initial guarantees, which are frequently nothing but loss leaders. In February 1986, Guarantee Security lured investors with an 11% one-year return, more than a percentage point higher than many competitors. But last year the company's renewal rates averaged just 8.4%. Meanwhile, it continued to attract new business with come-on rates as high as 10%. This wide gap between initial rates and renewal rates is ''a bit of an embarrassment to the industry,'' says Walter Lineberger, who runs an annuity brokerage firm in Topeka, Kans. High rates can also be a sign of a high-risk investment strategy that could lead to the financial failure of the insurance company. The 9.25% rate currently offered by American Investors Life in Topeka is backed by a bond portfolio one-third of which is in junk bonds. Another large insurer with perennially high rates, Executive Life of California, keeps two-thirds of its bondholdings in junk. In general, avoid companies with more than 20% of their bond portfolio in issues rated BB or lower. You can size up an insurer's portfolio in Best's Insurance Reports, which is available in the business section of major libraries. Also examine the company's overall financial stability. Just five years ago, one major annuity issuer, Baldwin United, filed for bankruptcy, jeopardizing $3.4 billion in annuities held by 165,000 investors. The annuity holders didn't lose their principal, but many were unable to touch it for several years and wound up getting lower yields than they were promised. To assure the safety of your investment, stick to companies that are rated A+ (superior) or A (excellent) by Best. Since these ratings can change, you should check periodically to make sure your company has not been downgraded -- Baldwin United was once an A+. If its rating does slip, you might consider a tax-free exchange to another annuity -- even if it means paying a surrender charge. For a list of 192 insurance companies that have received A+ ratings from 1978 through 1987, send $3 to Joseph Belth's Insurance Forum newsletter (P.O. Box 245, Ellettsville, Ind. 47429) and ask for a copy of the November 1987 supplement. One more caveat: be sure to look up the rating of the actual issuer of the annuity, not an affiliated company. A Merrill Lynch brochure for its Tandem annuity, for example, notes that the Tandem Insurance Group is a joint venture of Merrill Lynch and Equitable Life, a company with an A+ rating. But Equitable does not guarantee the Tandem annuities. And Tandem itself not only has no rating but was targeted last year for regulatory attention by the National Association of Insurance Commissioners. While this does not necessarily mean that Tandem's financial condition is shaky, says Belth, ''it does suggest that anyone considering a relationship with a targeted company should exercise caution.'' Thirty-nine U.S. states do have guaranty funds that offer annuity investors some protection against bankruptcies. But state guaranty funds maintain no pool of money in reserve. If an insurer goes bust, the state fund assesses charges against other insurance companies in the state to cover the losses. This can make reimbursement far slower than for failed banks. The questions of solvency, rate guarantees and surrender charges that preoccupy you when you are shopping for an annuity give way to other concerns as you near retirement. Then the major question becomes when and how you should start drawing from your account. Here, annuities provide a great deal of flexibility. You can take a lump sum and pay taxes immediately or you can choose one of several life-income options. Among the alternatives: a straight life annuity, which pays a fixed monthly benefit for the rest of your life; a period-certain plan, which pays you for life but continues paying your beneficiary if you die before a set number of years; and a joint and survivor annuity, which promises a monthly check as long as you or your beneficiary lives. Built into almost all annuity contracts at purchase are guaranteed payout rates based on ages and benefit options. But these guarantees are so low they are largely irrelevant. Instead, when you are ready to annuitize, compare the current payment rates being offered by your company with those of others and roll over your money if the differences are substantial. In February, for example, a 65-year-old man who had amassed $233,048 in a Northwestern Mutual Life annuity could have converted it to a monthly lifetime income of $2,268. The same account balance at Family Life, a Merrill Lynch subsidiary, would have generated just $2,072 a month. Given such wide disparities, you should never automatically take the annuitization deal offered by your present company. Sums up James Hart, president of Comparative Annuity Reports in Albuquerque: ''By doing a little shopping around, you could increase your monthly income by more than 10%.''

BOX: Key Words Translating annuity-speak

Insurance jargon can stop an annuity shopper cold. Here are the terms you need to know: Immediate annuity. A contract issued by an insurance company that pays monthly income, usually for life, in return for a large, nonrefundable amount of cash. The amount of income depends on the age and sex of the recipient, as well as the number of dollars put in. Deferred annuity. A contract in which investment earnings accumulate tax deferred until you convert the annuity to life income or withdraw the money. Fixed annuity. A deferred annuity that pays a fixed rate of return for a specified period, usually one to five years. The company then adjusts the rate yearly. Variable annuity. The return varies from day to day with the performance of mutual-fund-like portfolios chosen by the investor. An expense ratio of at least 1.5% a year comes out of your assets, which in most variable annuities are guaranteed not to fall in value below the amount paid in. Surrender charge. A penalty imposed by the company for withdrawing more than 10% or so of your accumulated investment in one year. This charge usually starts at 6% to 8% and declines yearly until it vanishes after seven years. Bailout provision. An option in many contracts that lets you withdraw all of your money without penalty if the rate of return drops by a certain amount, typically one percentage point, from the initially guaranteed rate. 1035 exchange. Moving money from one annuity to another without losing the tax deferral. Yes, it's exactly like an IRA rollover. Market-value adjustment. A charge against the accumulated value of a fixed annuity if you make withdrawals when interest is on the rise. The adjustment would also raise the cash-in value if rates drop.

BOX: What to Ask Five questions before you buy

Knowing the right questions to ask -- and the right answers -- can save you thousands of dollars when you deal with an annuity sales agent. Here are five crucial queries. 1. What kind of return will I get after my initial rate expires? No agent can guarantee a continuous string of high renewal rates, but a competent agent should be able to provide you with a three-to-five-year history for specific annuity contracts. If not, take the sale to one who can. 2. What penalties will the company impose on withdrawals? The agent should explain surrender charges in detail (as well as the federal income taxes and penalties on withdrawals). Any worthwhile plan should allow annuity holders to take out 10% of their account balance each year without charge. Surrender charges on larger withdrawals should start no higher than 8% and should disappear by the eighth year. 3. Is there a way to get all my money out without paying the company's penalty? The agent should explain the bailout provision if his annuity has one. This is a highly desirable escape clause in which, typically, the insurance company agrees to waive all surrender charges if its renewal rate falls one or more percentage points below the guaranteed initial rate. Avoid annuities that have < no bailout but do have high surrender charges. The reason: if the insurer decides to keep renewal rates low, you will pay dearly to liberate your money. 4. How do I know my investment is secure? The salesman should respond by citing the company's rating from A.M. Best Co. Limit your field to top-tier, financially solid insurance companies with a Best rating of at least A and preferably A+. You should confirm what the agent tells you by consulting the current edition of Best's Insurance Reports, which is available in most large public libraries. Also scan the Investment Data section of the report to see how heavily the insurer relies on noninvestment- grade bonds, which are better known as junk bonds. Avoid companies that keep more than 20% of their holdings in junk bonds. 5. Will the salesman's commission affect his recommendation? The answer you get will almost always be no. Follow up by requesting disclosure of the commission on each plan you are offered. Any agent or planner who purports to be helping you choose among several annuities should be willing to discuss the commission on each or at least to tell you which pay him the highest and which the lowest commissions. Even though you don't pay a sales fee directly, most insurers compensate their representatives with an up- front commission that ranges from 3% to 7% -- and sometimes as much as 10% -- of the premium. Spreads that huge can easily tempt a salesman to push an annuity that's better for him than for you.

CHART: TEXT NOT AVAILABLE. CREDIT:NO CREDIT CAPTION:TEN HIGH-YIELDING PLANS WORTH A LOOK DESCRIPTION: High-yielding single-premium deferred annuity plans.