To the people who sell them -- I've sat through a dozen presentations -- index annuities are an investor's treat, a "perfect investment" that goes up with the market but doesn't go down.

To their critics, these annuities are tricks. "They should be outlawed as a fraud on the public," said Larry Swedroe, an investment adviser in St. Louis. "I've never seen a good one," said Allan Roth, a certified financial planner in Colorado Springs. "It's a matter of how bad each one is."

Index annuities are insurance products that credit interest based on gains of a market index, such as the Standard and Poor's 500, but protect principal if the index goes down.

They don't invest directly in stocks but combine fixed-income investments and derivatives such as options and swaps tied to an index. That's how they can promise preservation of principal or even a minimum return with the potential for higher gains.

"That's an enticing combination after the markets of the past 10 years," said Robert Carlson, an investment adviser in Virginia with a middle-of-the-road view toward index annuities.

Although sales set a record of $30 billion in 2009 and are on a pace to top that amount this year, "it's not unusual for investors to be unpleasantly surprised" at returns, said Carlson, editor of the newsletter "Retirement Watch."

As a rule, newer index annuities capture only a portion -- sometimes a small portion -- of the gains of an index. Many sellers, who typically earn commissions from 5 percent to 9 percent or higher, gloss over this point. Other drawbacks include lengthy surrender charges, some 15 years or longer, and the complexity of the formulas to credit returns.

"The return formula is the real trick," Carlson said, with more than 30 in existence.

Formulas usually contain an annual "cap" no matter how high the index rises, and/or a "participation rate," or maximum percentage of the index gain to be credited, and/or a "spread" subtracted from the index's return.

Then there are several ways to calculate the return of the index, including "point-to-point' and "averaging" methods that can result in widely different numbers. The annuity comparison and shopping site, http://www.annuityfyi.com/criteria-equity-indexed-annuities.html, offers excellent consumer tips in evaluating index annuities.

Annuity sellers like to cite a paper from the Wharton Financial Institutions Center, an independently managed site at the University of Pennsylvania, which found index annuities have provided "competitive" returns. For five-year rolling periods, average annualized returns ranged from 9.19 percent in 1997-2002 (9.39 percent for the S&P 500) to 4.19 percent in 2004-2009 (S&P 500 lost 1.05 percent a year).

Half the time, though, annuity returns averaged 4.69 percent or less. Results were limited to 136 contracts from 15 companies that chose which products to submit, the paper said. The person listed first among three authors (not in alphabetical order) is Jack Marrion, president of Advantage Compendium. Marrion is also the author of "Change Buyer Behavior And Sell More Annuities," a book written to help "close more annuity sales," according to the introduction.

Roth and Swedroe said investors can build the equivalent of an index annuity by putting enough of their money in a certificate of deposit that will grow to the total principal amount at maturity, and the rest in a low-cost stock index fund. Even if the fund goes to zero, they'll get their original principal back. Any long-term stock gains will be taxed at a lower rate than the annuity interest, and they will earn stock dividends, which are typically excluded from annuity return formulas.

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(c) 2010 Humberto Cruz