Annuities—opinions about them may run the gamut, but their market certainly can’t be ignored. Total annuity sales last year reached $230 billion, as measured by the Limra Secure Retirement Institute.

“Annuities are designed as two-stage investments. Accumulation is stage one; distribution is stage two,” says John Graves, a chartered financial consultant in Ventura, Calif., and author of The 7% Solution: You CAN Afford a Comfortable Retirement.

But how can annuities serve these dual purposes? And which annuities are best for asset accumulation and which for income generation?

The Best Of Both Worlds?
“In general, the variable annuity with an income rider is the best solution,” says Joe Heider, regional managing principal at Rehmann, a full-service firm in Westlake, Ohio. “This allows investors to stay invested, with potential for higher returns if the market does well, but provides a downside guarantee if the market should take a downturn before or in retirement years.”

Heider isn’t alone in this view. Variable annuities (VAs) with an income rider have grown steadily more popular in recent years, though detractors charge that their fees are too high. “It is expensive relative to buying mutual funds, ETFs or professional managed accounts,” concedes Heider. “However, the additional expense in large part is buying the insurance to protect the income stream.”

Beyond the fees, VAs with guaranteed living benefits are subject to complex rules. “They are too complicated for the vast majority of consumers and their financial advisors to use,” insists Glenn Daily, principal at Sutter’s Mill Valuation Services in New York. “The economic valuation of these benefits requires option-pricing methodology, so it is very difficult to provide competent advice on the purchase decision as well as on optimal exercise decisions (including buyout offers) after purchase.”

Asset Growth
So other experts prefer a different sort of product for asset accumulation—separating that function from income generation. “One problem in the annuity industry is that variable annuities are sold for both growth and income, which is a mistake and one reason the industry continues to give itself a black eye,” says Stan Haithcock, the annuity maven known as “Stan The Annuity Man,” in Ponte Vedra Beach, Fla. “This one-size-fits-all, have-your-cake-and-eat-it-too nonsense is a major problem.”

Haithcock says that VAs are good accumulation vehicles but “not very competitive” from an income standpoint. “If you want to do growth, then do growth. But once you attach an income guarantee to it, that’s going to limit your investment choices and add fees which will eat into the growth,” he says.

To Haithcock, the best annuity for asset accumulation is a no-load VA. A good example is Jefferson National’s investment-only variable annuity (IOVA). Other insurers like Jackson National have entered the fray. With no purchase fees or early-redemption charges and low operating expenses, these vehicles offer tax-deferred growth, complete liquidity and exposure to hundreds of investment choices.

“Jefferson National offers nearly 400 underlying investment options, which is nine times more than the typical VA,” says Wade Pfau, professor of retirement income at the American College in Bryn Mawr, Pa., who is affiliated with the product. “Jefferson National provides a broad range of different asset classes, including more non-correlated asset classes, hybrid investments and liquid alternative funds that employ strategies for managing volatility like those favored by hedge funds and elite institutional investors.”

This flexibility is designed to allow clients and their advisors to be as aggressive or risk averse as they wish and maximize long-term performance. For clients who are especially concerned about market volatility, there are a couple of safeguard options. “Managed volatility subaccounts or guaranteed principal protection riders can offer additional comfort during the accumulation process,” says Judson Forner, director of investment marketing at ValMark Securities in Akron, Ohio.

The Downside
Yet IOVAs are not necessarily right for every seeker of asset growth. “That type of annuity is a fit in very specialized circumstances,” says Rehmann’s Heider, citing wealthy and young clients. “The trade-off here is that you’re deferring taxation but you’re converting potential capital-gains treatment into ordinary income. The primary purpose of annuities should be protecting tax accumulation and some type of enhanced income protection.”

Indeed, some experts go so far as to say that using annuities of any type to grow assets is usually a mistake. “I don’t think an intelligent planner or advisor would want to use an annuity as an asset-accumulation vehicle,” asserts Kurt Cambier, a senior partner at Littleton, Colo.-based Centennial Capital Partners. “An annuity is a protection and income vehicle.”

Generating Income
In considering annuities for income, you need to bear in mind factors such as timing, age and cost. Single-premium immediate annuities (SPIAs) begin payments within the first year, whereas deferred-income annuities (DIAs) allow clients to put off payments until retirement or later. “They are like term life insurance in that they come with few bells and whistles,” explains Pfau. “They are easy to understand.”

SPIAs offer the highest contractual guarantees: a lifetime of payouts can start as soon as a month after the contract is issued. Because the income is guaranteed, the insurance company assumes the risk. The longer you (or your spouse) live, the more you receive in total. These annuities can be customized. You can add a cost-of-living/inflation increase and choose payment intervals, for example.

But they offer no asset growth or liquidity, unless you opt for a cash-refund option or other terms besides life-only, which increase costs. “Immediate life annuities, given today’s low interest rates, are expensive in terms of the amount of money [required] to buy guaranteed income,” says Heider.

Some advisors recommend buying a series of SPIAs over several years of rising interest rates, not unlike purchasing staggered CDs or laddered bonds. “Each year the rate of return is slightly higher,” notes author Graves.

Others prefer to hold off on SPIAs until clients are well into retirement to maximize the payout. “Generally, I would recommend a single-premium immediate annuity for someone in their late 60s, no earlier, and usually their 70s and beyond,” says Eric Tom, a financial advisor with the MetLife Premier Client Group. “The income payout is higher because of their age.” For clients in their 70s, he’d recommend “supplementing it with a living income rider which still allows access to principal.”

Longevity Annuities
For younger clients, DIAs allow assets to grow until the client receives distributions. Because of the income guarantee, however, the expenses tend to be higher than IOVAs’. Longevity annuities, which are a type of DIA, “don’t start the guaranteed income until later in life when survival probabilities are lower, and so it is cheaper for insurance companies to guarantee these promises,” says Pfau. “They are useful for helping to set a planning horizon in retirement. If you know that guaranteed income begins starting at age 80, for instance, then you have less worry about drawing out your assets through 95 or 100. But you do still have to worry about inflation.”

Longevity annuities are typically intended to supplement other retirement income late in life. The later the payments start, the larger the amount of each payment. “We wouldn’t allocate any more than 25% or 30% of someone’s assets to something like that, and usually less,” says Cambier at Centennial Capital Partners. Others think even that figure is high and that the limit should be no more than 15% of a client’s assets.

To be sure, one negative is a lack of flexibility. “The good news is that the income is guaranteed for life, but the bad news is the income will never change,” observes Heider. “What is attractive in 2014 may not be that attractive in 20 years as a result of higher interest rates and inflation.”

At the moment, longevity annuities represent only 2% of all annuities sold, according to Haithcock. But that may be changing. In July 2014, regulators approved using longevity annuities in 401(k)s and individual retirement accounts. This means that instead of filling these tax-deferred retirement vehicles with mutual funds, clients can instead designate qualified longevity annuity contracts (QLACs). No other type of annuity was approved for this purpose.

“In five years, QLACs will be the No. 1 owned annuity in the country,” Haithcock predicts. “This is going to change everything in the annuity world.”

Switching Annuities
At this point, however, clients might want to accumulate as much as possible in a no-load VA and then, when the time comes, transfer some or all of those funds to an SPIA or DIA. That’s not difficult, says Forner of ValMark Securities. “Non-qualified or after-tax annuities can be transferred through a 1035 exchange … without creating a taxable event,” he explains, referring to Section 1035 of the U.S. tax code, “as long as the owners and annuitants are identical between both existing and new contracts.”

In general, taxes aren’t due until the holder starts making withdrawals. “The tax occurs on the monthly or annual payments, not on the entire taxable gain on exchange,” notes Tom of MetLife.

Some VAs, though, charge surrender fees for early withdrawals, which would have to be weighed against the advantages of making the transfer.

Annuity Guarantees
To be sure, this annuity strategy could have unexpected consequences. Contractual guarantees are only as good as the guarantor. “There’s always a risk,” says Cambier. “Not so much of the market collapsing but of the insurance company collapsing.” With guaranteed minimum benefits, distributions stay the same regardless of market performance or interest rates, which can put a strain on the insurance carrier that’s offering the guarantee. “The primary risk is, does the insurance company have the financial strength to maintain your income guarantee? Did it hedge its liabilities appropriately?” says Cambier.

Making matters worse is the fact that indexed annuities, unlike VAs, are not regulated by the Securities and Exchange Commission but, rather, are treated as insurance products. “A lot of people are selling these things who have merely passed a state insurance test, which practically anybody can do,” warns Cambier.