Investors looking for a safe haven for their fixed-income dollars or retirement savings often buy annuities. Annuities are sold only through insurance companies. They are a contract between you and the insurance company and typically provide for tax-deferred earnings.
Annuities contain a number of insurance guarantees,
including the option to "annuitize," or turn the principal
into a lifetime stream of income. But investors may find that fees
can be steep and earnings are taxed as ordinary income even if it's
a long-term capital gain.
Annuities, even when sold though a bank, are not insured
by the Federal Deposit Insurance Corp. The safety of your principal
rests on the financial strength of the annuity provider. If the
insurance company fails, your annuity might be covered up to $100,000
by your state's guaranty association. The associations operate under
their state laws. What they cover and how much they pay varies from
state to state.
||Pros and cons of annuities
What's good about an annuity?
bad about an annuity?
You pay the insurance company a certain amount of money and the
insurance company guarantees you certain periodic payments for the
life of the annuity. This can amount to a lifetime stream of income.
The insurance company is betting it can invest your deposit and
make more money off it than it will have to pay you.
Annuities often offer higher interest rates than certificates
of deposit, but the term "fixed-rate" is a misnomer when
it comes to annuities. Unlike a CD, where the rate is fixed for
the full term of the CD, fixed-rate annuities have no maturity date
and often guarantee a rate only for the first year. The interest
rate usually drops after the guaranteed period and is adjusted annually.
The insurance company may impose a penalty period
for several years where you'll pay steep surrender charges if you
withdraw money during that period. Withdraw money in the first year
and you may pay an 8-percent penalty. The penalty typically decreases
by 1 percent a year after that.
Since there's a tax-deferral feature to annuities,
you may have to pay a hefty 10-percent penalty to the IRS if you
withdraw money before age 59½. Another consideration is that
earnings on annuities are taxed as ordinary income by the IRS regardless
of how long you've held the investment.
Variable annuities combine elements of life insurance, mutual funds
and tax-deferred retirement savings plans. While their hybrid nature
offers investors some features they can't get elsewhere, it also
makes them complicated products.
When you invest in one of these, you select from an
array of mutual funds in which to allocate your investment dollars.
Typical offerings might include balanced mutual funds, money market
funds and several international funds, among others. Along with
the tax-deferral benefit, you also get income guarantees you can't
get with other investments. For instance, variable annuities, for
a fee, offer a death benefit feature.