Annuities are tax deferred investments that are sold by insurance companies to help build a cushion after retirement. This type of insurance helps you increase your savings, protect what you've saved, or even create a source of income after you've retired. There are many different kinds of annuities, so before you invest, read which is right for you.
Variable Annuities
A variable annuity is a type of retirement fund that allows you to choose from a variety of investments that are designed to give you a chance for a higher return through participation in the stock market. Eventually, this investment provides you with income after you've retired depending on the performance of your investment.
Because there is only a chance for a high return, there are a lot of risks involved with variable annuities. After you retire, you'll begin to pay taxes on your investments. The funds are treated as regular income and are subjected to IRS income taxes. There are also commission fees and management fees that are attached to variable annuities. Commission fees are often 4% while management fees can be as high as 2-3% per year.
Fixed Annuities
A fixed annuity is similar to a certificate of deposit (CD) investment because they pay guaranteed rates of interest, although the rates can be higher than a CD. There are two options with fixed annuities: immediate or deferred. An immediate annuity is one that you'll make one big payment and receive payouts almost immediately after payment. A deferred annuity is one that you'll be able to save up over a period of years rather than one lump sum but won't have access until a particular time in the future.
Fixed annuities have a guaranteed rate of interest, which is appealing to someone who is worried about risk. However, they are also only for a limited period and will begin to decrease in interest after a specified date. Additionally, the payments do not increase to keep up with inflation. This fact means that the value can increase or decrease over time based on the market.
Equity-Indexed Annuities
An equity-indexed annuity is perfect for someone who cannot choose between a fixed or variable annuity because it's a combination of both types. It can give you the best of both worlds because of its guaranteed return, and you'll also have a shot at higher gains. In most cases, investors can see around 2-3% minimum return. Additionally, you'll have the opportunity to participate in the stock market while it's climbing. If you're worried about your investments, an equity-indexed annuity protects you when share prices fall.
While an equity-index annuity may seem perfect, there are some downfalls. An equity-indexed annuity is incredibly complex. They come in a wide variety of forms, and this can make it difficult for some investors to understand. Marketing pitches can be deceiving in some circumstances to the untrained ear. Just like with a variable annuity, you'll have to pay surrender charges which can be as high as 20% and last for 15 years or more. Finally, you may not receive the full return of the market index that your investments are tied to.
