Money invested into annuities

Annuities Basics

Annuities are often associated with retirement investing and other long-term financial investment products. However, annuities are actually considered to be a type of insurance product. They certainly do serve as a component of an investment strategy and can help individual investors plan for retirement by providing guaranteed income for a set period of time. The amount of income and the length of payments is dependent on a number of factors.

Types of Annuities

Since an annuity is designed to offer payments to the investor at a later date, there are different products that facilitate long term planning in different ways. With a fixed annuity, the investor purchases a guaranteed payout. This can be a lump-sum payout for a later disbursement, or a payment stream that begins and ends on a specific date. The term of these payments can be set to end on a specific date, or to last for the life of the recipient.

Variable annuities, on the other hand, are at the mercy of their underlying investments. With these products, the annuity cost is invested, and the payout amount is linked to the return on those investments. If these investments see large returns, the annuity will pay more. Conversely, if these investments suffer losses, the annuity will as well. Depending on the current market climate and the intent for the annuity disbursement, a variable annuity could be an advantage or a detriment.

Annuities and Tax Liability

Depending on the type of retirement investment, a tax benefit is often gained by the investor. Some retirement accounts use tax-deferred earnings, meaning that the cost of these products is paid with pre-tax dollars. With others, the products are purchased after taxes, but the gains on the investments are then shielded from tax liability. With annuities, pre-tax dollars are used to fund the purchase. However, when the insurance company initiates disbursement, that income is subject to tax.

Most of the tax sheltered retirement investment options have yearly limits associated with them. This is due to their use to defer or deflect taxation. Annuities carry a strong advantage in that there is no yearly limit. This means that the investor can gain the benefit of a large amount of pre-tax income working as an investment. When combined with a variable annuity, this represents a great strategy to take advantage of a high performing market.

Fees and Commissions

Annuities often carry high commissions with them. In some cases up to 10% of the annuity can be paid in fees to the insurance company. Furthermore, the fees on a variable annuity can often rise to 1.25% or more. When the market is performing poorly, this can be a significant drain on a person's investments. Also, there are surrender charges for people who require the disbursement of their annuity before their intended date. These fees can begin anywhere from 7-20%, and typically decrease by 1% every year thereafter.

Last Updated: January 30, 2017