If you need another source of income other than your 401(k), an annuity may seem perfect. Annuities are designed to give you regular income after you retire, so you want to know everything before you enter into a contract. Here are 10 things you absolutely have to know before buying an annuity.
1. Annuities are not tax deductible.
One of the biggest misconceptions about annuities is the belief that they are tax deductible. The contributions you put into your investment is tax-deferred, but the payments will be taxed as income when you begin to withdraw.
2. Some annuities may not be transferable after death.
Some annuity contracts prevent beneficiaries from receiving money if you pass away. An example of this is an immediate annuity, which is a "lifetime annuity." To bequeath the money to a beneficiary, you must purchase an alternative type of annuity which is referred to as a “joint and survivor annuity.”
3. Annuities are divided into two main basic types.
There are two main basic types of annuities: immediate and deferred. An immediate annuity is paid in one lump sum and begins payout within 12 months of the premium purchase date despite your age. A deferred annuity has spaced out premium payments, and income may only be withdrawn after the age of 59 and a half.
4. Annuities can be further broken down into fixed or variable forms.
After the two basic types, annuities can be further broken down into fixed or variable forms. These terms refer to the way that your money is invested. A fixed investment guarantees payout whereas a variable annuity is high risk, but has the possibility of a much higher payout due to the ability to dabble in the stock market to increase investments.
5. Annuities can have high fees and commissions.
One of the biggest issues with annuities are the fees and commissions you’ll have to pay for during the life of your investment. These fees are often hidden but cut into any profits that you can hope to make. Commissions can be as high as 10% while other fees combined account for another 2-3% annually.
6. Annuities may be permanent.
When you purchase an immediate annuity, you’re locked into the contract after a short period of time. If you need a large amount of money quickly, you cannot retrieve what you’ve spent. However, there are some types of annuities that allow you to exchange your existing one for a new one, such as a fixed annuity.
7. Annuities aren’t all the same.
When you’re looking for the perfect investment plan, you need to shop around to several different companies. Annuities are only as good as the business underwriting them, meaning you can get a better deal elsewhere. Be sure your financial investor is focusing on your exact needs, rather than giving you a “cookie-cutter” annuity.
8. Annuities allow a “free look period.”
A free look period is an amount of time where you’re authorized to get your money back without question after you've entered into an annuity. It’s important to research how long this period is within your state, as the law is different in each area. Most states have a free look period of around 10 days.
9. Annuities aren’t for everyone.
There are many ways to save money, and financial experts state that annuities may not be for everyone due to the high-risk environment. Some experts even claim that an annuity is unnecessary when you own a pension plan.
10. Annuities are not adjusted for inflation.
Annuities are not protected against inflation, and this can put a significant dent into your savings plan. However, there is an “inflation-protected” annuity that adjusts each year based on inflation. These types of plans reduce early annuity payments significantly, around 20-30%, depending on your age. Some investors claim that inflation-protected annuities can surpass an ordinary fixed annuity as soon as year eight.
