The benefits of annuities are often overshadowed by their negative qualities—especially their notoriously high expenses and illiquidity.
While annuities make sense for some, they are not the best choice for everyone. For that reason, it's important to be sure to research all your options first before jumping into this type of investment.
If you've recently been sold an annuity that you now realize just doesn't make sense for you, you may be able to get out of it unscathed by exercising your "free look" provision. This is a kick-the-tires grace period in which you can terminate the policy and get your money back without paying a surrender charge. Free-look periods differ by state and insurer but usually last between 10 and 30 days after purchase.
If you are in your 30s or 40s and just learned that you are locked in until age 59½ but want to get out now, it's important to note that you are required to pay taxes and penalties only on the gains in the annuity. For instance, if you invested $30,000 in a variable annuity in 2008 and just got back to even, you won't have to pay taxes or gains if your distribution is $30,000 or less.
(Read more: Annuities: More cons than pros?)
You may still have a surrender charge to consider, but if it is nominal, it may be worth cutting loose to avoid tying up your money for decades to come.
If you have a highly appreciated annuity and don't want to create a tax time bomb for you or your heirs, you may (likely) have the option to annuitize the product.
To annuitize is to transition your existing fixed, variable or equity indexed annuity into a stream of income through the insurance company. Partial distributions are taxed on a last-in first-out basis—gains come out first. If you fully annuitize a product, it will be taxed on a pro-rata basis. Each distribution will be a proportionate blend of return of principal and gains, thereby reducing the tax hit.
If you have a highly appreciated annuity and no remaining surrender charge but do not want to annuitize the product, you may conduct what is called a "1035 exchange" to another annuity product of your choosing without suffering a taxable effect.
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You'll simply transfer the basis from one annuity policy to another. However, do not ever conduct a 1035 exchange into another product with a lengthy surrender charge.
If you are beyond your free-look period but miles away from the end of your surrender period, you are basically hosed, as my neighbors to the north say.
Fear not—you still have some limited options to make the most of this situation. Most annuities offer a surrender-free withdrawal option, available in each contract year. (Your contract year begins the day you sign the annuity contract and ends 364 days later.)
Some annuities will allow you to take 5, 10 or even up to 20 percent out of the contract each year without subjecting the distribution to a surrender charge.
You must still be cognizant of the taxable implications of the surrender, but penalty-free withdrawals allow you to whittle the annuity down without getting slammed by an onerous surrender charge.
If you happened to purchase your annuity inside of an individual retirement account or Roth IRA and have no surrender charge, you can transfer the entire balance to another IRA as a trustee-to-trustee transfer, just as you would with any other IRA asset, deferring the tax.
(Read more: Do annuities fit into retirement plans?)
If you do have a surrender charge, you may send your penalty-free withdrawal to another non-annuity IRA without paying tax as well. And in certain cases, you may also be able to take your required minimum distribution from an IRA annuity without paying any surrender charge—if you're over age 70½.
The final annuity disadvantage that now goes without mention is that annuities are inherently complex vehicles, combining investment options with actuarial calculations.
Sadly, many of the agents selling the vehicles (especially equity indexed annuities) don't even know exactly how they work. It may be advisable to avoid investing in any investment vehicle that you don't understand, but this maxim is especially true in the case of annuities, because with the complexity comes additional expenses, tax consequences and illiquidity handcuffs.
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There are, certainly, appropriate uses for annuities, but you must thoroughly research all your options beforehand—and if later you want to unload, be very careful how you choose to get out.
—By Tim Maurer, Special to CNBC.com. Tim Maurer, a certified financial planner, is a vice president at the Financial Consulate and an adjunct faculty member at Towson University. He has co-written two books with best-selling author Jim Stovall. Their most recent release is "The Ultimate Financial Plan: Balancing Your Money and Life."