What exactly is an annuity?
Annuities are sold by insurance companies, but are decidedly
different from an insurance policy. In essence, you buy an annuity in exchange
for a series of payments that are distributed at specific points of the life of
an annuity contract. Many annuities have an indefinite payout schedule; the longer
you live, the more you receive.
Not surprisingly, annuities
come in various types. First, you can choose whether you want to receive payments
right away or put them off until later. This is the primary difference between
"immediate" and "deferred" annuities. Additionally, you can
choose between a fixed annuity and a variable product. A fixed annuity has an
established payment that the company usually announces on an annual basis. By
contrast, a variable annuity is effectively an insurance product wrapped in a
mutual fund. You as the owner of the annuity can choose how your annuity funds
are invested. Your choices include stocks, bonds and money markets. It has a set
payment amount that may be augmented by additional payments depending on how the
annuity's investment portfolio has performed.
dictate what sort of annuity may work best. For instance, many retired people
buy immediate annuities to provide a steady stream of reliable income. By contrast,
younger people may opt for deferred annuities. The primary reason is that money
in the annuity grows tax-free until they set up a regular payout schedule.
approach annuities as you would any sort of investment decision. For instance,
don't make the mistake of providing unnecessary layers of tax-free growth. Following
a similar statement from the National Association of Securities Dealers, the Securities
and Exchange Commission recently declared that variable annuities often are unsuitable
investment options when part of a tax-deferred retirement plan, such as a 401(k)
or an individual retirement account. Since those are already tax deferred, the
SEC pointed out that buying a deferred annuity meant that investors merely paid
extra fees to an insurance company for tax benefits they are already receiving
free of charge.
Taking that point a step further, be sure to
keep an eye on fees and expenses associated with annuities. Not only do various
annuities levy all different sorts of costs, some hit you with significant penalties
if you choose to take your money out of the contract within the first five or