Understanding Annuities Pros and Cons
Everyone wants to be financially secure after they retire, and no one wants to outlive their money. These factors generally prompt investors to explore annuities. Pros and cons of annuities must be considered, so that if you decide to purchase annuities, pros and cons will have been completely investigated and understood.
Advantages of an Annuity:
Annuity plans provide tax benefits, but a distinction must be made between deferred and immediate annuities. Deferred annuities provide compounded interest on a tax free basis until payouts are made via withdrawals or annuitization. Immediate annuities provide fixed payments until a specific event occurs to terminate the contract, such as the owner’s death or the end of a defined period of time. They are taxed in a manner that treats a constant percentage of the payment as a return of principal.
Annuities provide flexibility in terms of payouts. Additionally, since annuities are life insurance contracts, designated beneficiaries can avoid probate. Annuities are generally excluded from bankruptcy proceedings as well. And there are state guarantee funds that back annuities if the insurers that wold the plans can’t make good on their payment promises. This mitigates exposure to the risk of an insurer’s insolvency.
Annuity Disadvantages:
Annuities are expensive to buy. Insurers must recover a commission on the plan that is paid to its agent. This usually totals between five percent and ten percent of the premium you pay. Insurers must also recover maintenance and ancillary benefit costs, while receiving a reasonable profit.
Annuities are illiquid, and while it is easy to add funds to an annuity plan, money can only be withdrawn with surrender charges imposed. These charges differ according to the annuity contract terms, but generally, the higher the agent’s commission, the higher the surrender charge and the longer the charge is imposed. Withdrawals from annuity plans are also subject to penalty taxation if they are taken before the plan owner reaches the age of 59.5 years.
Annuity buyers must be careful of “bait and switch” tactics. Some insurers issue deferred fixed annuities and have the discretion to credit interest rates as they see fit. These firms may lure buyers with high introductory rates, but then reduce those rates significantly after an initial guarantee period. Policyholders in such cases may be trapped because they fear high surrender charges.
Be Sure of Your Investment Goals
Annuities can be valuable contributions to your overall retirement strategy, but you should always consult with a financial adviser before buying any investment plan.
by Steven Hart
