Annuities can help build sizable retirement nest egg, reduce taxes.

When you think about retirement planning, most likely Individual Retirement Accounts (IRAs) and 401(k) plans come to mind.

But do you ever think of annuities? They, too, can increase your income for retirement and reduce your taxes along the way.

Earnings on annuities accumulate tax-deferred until the time of withdrawal. However, unlike IRAs, 401(k)s, and other retirement vehicles, there are no limits on how much you can contribute. As a result, you can build a sizable retirement nest egg while sheltering your income.

It is important to understand the various types of annuities on the market today to determine if and how they fit into your retirement investment portfolio and to identify the risks that may be involved.

Basically, an annuity is an interest-bearing contract, typically issued by an insurance company to help you save for and fund your retirement. You can also buy an annuity from banks, mutual fund companies, stockbrokers, and others who have teamed up with insurers to market their own products.

Like other retirement plans, you generally cannot withdraw the money without penalty until you reach age 59 and a half.

When you're looking to buy an annuity, you have several options. When you think about retirement planning, think in terms of time of payout and interest rates.

For example, you can purchase an immediate or deferred annuity. Immediate annuities typically are purchased with a one-time deposit - called a single premium generally with a minimum of $10,000. Payouts begin as soon as you've paid the premium. On the other hand, deferred annuities start payouts at a specific future date.

You also have the option of investing in a fixed-rate or variable annuity, depending on your income needs and willingness to take risks.

With a fixed-rate annuity, you lock in on the current interest rate and are guaranteed specific payments for the rest of your life A benefit of purchasing a fixed annuity is that the sponsor guarantees to return your principal. This is not the case with variable plans.

With a variable annuity, you can choose from several investment alternatives, including stock, bond, and money-market mutual funds. You also have the option of moving your invested money around in the mutual fund family without triggering any taxes.

However, your investment will be subject to market fluctuations, which could result in your losing money. What's more, since annuities and insurance products are not insured by the Federal Deposit Insurance Corp. (FDIC), you also risk losing your principal if the issuing insurance company is unable to meet its obligations.

Be aware, too, that various management fees can bite into profits generated from your variable annuity. Typically, you'll pay about 2 percent a year, plus $30 to $50 in annual "contract charges" to the sponsor of the fund. It's important to consider these fees when estimating the return on your investment.

The amount of your annuity payments will vary depending on the payout option you select. For example, your payments will be higher if you choose a "single-life" (also called "straight life") annuity. These provide payments, based on your age, when you begin withdrawals, and your life expectancy, for the duration of your life.

A joint-and-survivor annuity, based on the joint life expectancies of you and your spouse, provide payments for as long as you or your spouse are alive.

Since the joint life expectancy is longer than a single one, your annuitized payments will be lower than those for a single life.

Another choice is a "certain period" annuity, which makes payments for a specified period of time - usually 10 to 20 years - even if you die before that period expires. The payout on this type of contract generally will be less than that for a single life but more than for a joint-and-survivor annuity.

Before investing in an annuity, make sure the insurance company that will sponsor the contract is financially healthy. Also, find out from the sponsoring company the interest rates that have been paid out over the last five to 10 years and how interest rate changes are calculated. This will give you an idea of the annuity's overall performance and help you identify the annuity that provides the best long-range financial security.

Poteshman is a certified public accountant and president of Poteshman Consulting International & Co. in West Los Angeles.