Insurance companies sell annuities as a way to provide a guaranteed retirement income to people who don't have a traditional pension plan. But look at the fine print, and you'll see why you should be cautious about this long-term investment vehicle. Here are three reasons annuities may not be the best choice to fund your retirement.

Man is upset by a poor investment choice.

Annuities have downsides that investors should be aware of. Image source: Getty Images.

1. Nothing will go to your heirs -- unless you pay extra

The main sales pitch for annuities is that they provide a regular income stream in retirement that lasts for the rest of your life. If the money you invest in an annuity is depleted before you die, you will continue to receive the same amount of income. That's because insurance companies pool your money with other policyholders' money, invest it, and then distribute annuity payments to everyone. 

For many retirees, the idea of receiving predictable payments for the rest of their life, guaranteed, is comforting. But there is a flip side to that coin: With many annuities, if you die before your original investment has been repaid, the leftover money goes to the insurance company, not to your heirs. And the monthly payments will stop altogether. This means you will not be able to leave any unused money in your annuity contract to your spouse, children, or other loved ones.

Some annuities offer an option to leave a survivor benefit to a spouse or other heir, but you have to pay extra for this, and it can be expensive. This is known as a qualified joint and survivor annuity, and there can be strict rules governing how payments to spouses or other heirs are distributed -- and annuity payments made to an heir after your death can be half the amount you received.  

2. Big fees

Annuities come with big initial fees in the form of sales commissions that can be as high as 10% of the lump sum you're depositing, as well as charges as high as 7% if you tap your funds before a "surrender period" has expired. (Surrender periods usually range from two years to more than 10 years).

Other fees and charges associated with annuities include administrative fees and management fees, along with a host of expensive add-ons (or riders) for items such as the aforementioned survivor benefit, which can each cost as much as 1% of the policy's value per year. These fees and costs can hurt your annuity payments in one of two ways -- some riders lower your monthly payments at the outset by a fixed dollar amount, while the cost of other riders is taken from a percentage of your annual investment returns. Either way, the fees and charges on annuities will conspire to diminish your retirement income.

Given the hefty fees, it may be best to invest only part of your savings in an annuity and keep the rest in a diversified portfolio of stock and bond mutual funds that provide continued growth while giving you access to your money in an emergency.   

A woman is surprised by how few groceries she was able to buy.

Accounting for inflation preserves your purchasing power. Source: Getty Images.

3. Keeping up with inflation will cost you extra, too

The majority of annuities are not adjusted for inflation, which means you'll receive the same level of income at age 85 that you did at age 65 -- even as the cost of living continues to rise.

Prices in the United States were 42.35% higher in 2017 than they were in 2000, according to the Bureau of Labor Statistics -- and that was a period of low inflation. Consider what will happen to your standard of living in retirement as prices for groceries, medication, and fuel continue to rise while your annuity income stays exactly the same. Your purchasing power and standard of living will slowly be eroded.

Some annuities offer the ability to index your payments to inflation, but that requires you to tack on an inflation protection rider, an optional feature that raises your payouts on the anniversary date of your annuity contract each year. You can arrange to have the payments you receive increased by the annual inflation rate, or by a percentage that you choose (usually 1% to 5%). These inflation protection riders can be pricey, and they reduce the amount of income you receive from an annuity at the very start.

A better option would be to keep your savings invested in a diversified mix of stocks and bonds, where they can earn interest that surpasses the annual rate of inflation, preserving and even growing your purchasing power in retirement.    

There are many types of annuities, and most are complex and often confusing. While the promise of a guaranteed income for life might sound enticing, read the fine print of an annuity contract and you'll see why many people find these to be poor long-term investments.