1What Is An Annuity?
The term annuities–especially as related to the form of product you hear pitched as an investment–confuses people. Formally speaking, an annuity is a yearly payment. It’s made to an investor usually on a monthly or otherwise pre-determined basis. In the world of investments and insurance, annuity means a tax-deferred investment, or as it’s called, a tax-deferred annuity. As such, annuities can be an income stream for life. They can be viewed as a way to invest for your retirement also. And they give you certain tax breaks, by allowing you to defer any gains the annuity makes when it grows. There are basically two types of annuities: fixed annuities and variable annuities.
2What Can You Do With An Annuity?
You can invest in an annuity and squirrel-away your cash, – tax deferred for your retirement. Then… you can exchange that money you’ve accumulated for a guaranteed monthly income for the rest of your life. In some cases, if you’ve tapped out your yearly contribution limits to an IRA or employer plan, an annuity can be a good way to sock away a boatload of cash, tax deferred. But they are not without their limitations, including high expenses; hefty commissions paid to the salesman who sells it, and very meager types of investment choices within the annuity. All that, and if you ever do want that guaranteed monthly income for life, you surrender the annuity to the company who issued it to you in exchange for that monthly payout.
The idea with an annuity, like any retirement account, is to invest your cash and let it compound tax-deferred. Then when you’re ready to retire, tap the cash and start pulling money out by making “partial surrenders”. Sure, when you take the cash out you’ll owe income tax. But chances are when you hit retirement age, you’ll be in a lower tax bracket anyhow. So don’t worry too much about the tax consequences as your major determinant on what you do, or your major concern. If you’re going to put your money into an annuity, you’re much better off worrying over selecting one that isn’t going to eat you up in administrative fees and other costs the insurance company is going to ding you with annually. You’ll want to find one with the lowest fees available.
4Positives & Negatives
Annuities have their positives and their negatives. Let’s review. They’re an investment underwritten by an insurance company. Put your money in, it compounds tax-deferred. When you’re ready to begin pulling it out, you can annuitize the account and guarantee yourself an income for life. Not a bad deal. But don’t overlook the fees. Insurance companies are notorious for assessing you administrative fees, mortality fees, and every other fee imaginable. All told, that could chew thru 3, 4 maybe even 5 percent of the cost of your annuity during a year. Also, the investment selections aren’t the greatest. They’ve improved–for sure–for variable annuities, which have more mutual fund selections today. But again, you’ll also pay for those fund fees. Which is a double whammy. So take all this into consideration.
5Fixed Vs Variable
There are generally two types of annuities—fixed and variable. For a fixed annuity, the insurance company guarantees you get a minimum rate of interest as long as you have the annuity. The insurance company also guarantees that the periodic payments you receive from them is a guaranteed amount, per dollar in your account. These payments can last for a definite period–like 20 years; or for an indefinite period, say your lifetime, or the lifetime of your spouse. And that, my friend, is what makes them so appealing, especially to seniors. What I’ve just describe to you is what is called a fixed annuity or an immediate annuity. Everything I just mentioned is fixed. But remember they come with hefty fees.