Q. I have a 33-year-old friend who is a schoolteacher. She contributes the maximum amount every month in the Teacher's Retirement System of Texas. She is afraid that she still won’t have enough money when she retires because this insurance rep who came to her school told her that the TRS may not be around when she retires.

I know she doesn't have very much money in an emergency account. I told her she needs to build up that account before she starts any further investing. She wants to start investing $50 a month in an equity-indexed annuity. Is this a good investment for her? Or is there a better product for her to invest in if she insists she needs to start investing now? —D.R., by email from Austin

A. The equity-indexed annuity will be great for the salesperson, but it is unlikely to be a good investment for her. I know this isn’t how it appears in the sales talk, which makes these contracts sound like a sure thing. But the reality is that most people don’t understand exactly what their investment return is based upon. So here are some basic facts:

  • First, equity-indexed annuities don’t include the dividend income of the underlying index. Historically, dividends have accounted for nearly 50 percent of the total return on common stocks.
  • Second, the typical contract has limitations on the return from stock appreciation. This limitation can be a maximum percentage upward in any given year, or it can be a percentage of any appreciation. Either way, it further diminishes the return an investor is likely to receive.
  • Third, of all investment-oriented insurance contracts, equity-indexed annuity contracts have the most onerous penalties for early redemption. They also have the longest holding periods.
  • Fourth, equity-indexed annuity contracts are popular with insurance salespeople because they offer some of the highest commissions in the industry. I’ve heard of commissions as large as 10 percent, nearly double the commission on typical load mutual funds. It is the size of the commission, not the quality of the investment, that accounts for the intense sales effort.

Finally, I’m not alone in having a low opinion of this product. Anyone who wants to get an idea of the problems with this product and the methods used to sell it can learn plenty simply by Googling two phrases: “equity-indexed annuities” and “class-action suits.”

Q. My wife and I are 65. I am retired, and my wife expects to work until age 70. We plan to hold off taking Social Security until age 70. We had planned to buy immediate annuities at age 70 with a portion of savings of about $900,000. Our house has no mortgage. We have about $200,000 in money market and short-term bond funds earning very little interest. It seems that an immediate annuity pays little more at age 70 than at age 65.

Should we just go ahead and put some of the $200,000 into a life annuity? The extra income would be nice but not necessary. —C.W., by email

A. It is true that a single life annuity for a male at age 70 only brings about 13 percent more in monthly payment than the same annuity purchased at age 65. Visiting www.immediateannuities.com, for instance, a $50,000 single life annuity for a 65-year-old man would pay $316 a month. It would pay $358 a month for a 70-year-old man, an increase of only $42 a month.

Buying a life annuity, however, may not be a good way to increase the actual yield on your money. With a life expectancy at age 65 of about 17 years, you would have an implied yield on a life annuity of about 3.1 percent— and you'll have to live a bit over 13 years just to get your original investment back. That 3.1 percent is less than the yield on a 10-year Treasury obligation.

With such a limited likely return, this would be a good time to go on a buyer's strike and hold cash, since you don’t have an immediate need for income.