All About Annuities

Every once in awhile I get a question about annuities -- what do I know about them, what do I think of them, etc. I don't really have a single post that describes what annuities are, how to handle them, etc., so when I saw this piece from the Wall Street Journal that talks about annuities, I knew I had to post on it.

This specific piece describes many of the basics including how annuities work, the difference between fixed and variable annuities, how annuities have been affected by recent market conditions, and whole host of other questions. If you're interested in finding out more about annuities, this article is a good place to start.

If you're interested in the pros and cons of annuities, here's a piece from Bankrate. They start with thoughts on when an annuity should be considered:

Only after you've contributed the maximum to your 401(k), SEP, Keogh, IRA and whatever other tax-deferred opportunities are available to you, should you consider an annuity.

Then they list the benefits of annuities as follows:

• Lifetime income is guaranteed
• Earnings are tax-deferred
• There is no limit on how much you can contribute
• There are no income restrictions
• You can switch investments within your contract without paying taxes
• You get a premium for outliving your life expectancy

And the cons of them:

• Fee and commissions can be high and cut deeply into your return. Look for low-load or no-load contracts with low fees.
• Annuities are generally bought with after-tax dollars.
• At payback time, income is taxed as ordinary income, even if most of it is from capital gains. Not good if you're in a 28 percent or 39.6 percent income-tax bracket and your capital gains tax rate is 20 percent.
• Annuity talk can sound like doublespeak, making it hard to separate the good contracts from the bad ones.
• An annuity is a long-term investment, and bailing out early can kick up penalties, taxes and surrender charges.
• You could be paying for life insurance you don't need.
• You need a long stretch of time and a big chunk of money to make it work.

Personally, I haven't used annuities yet though I may do so in the future. My biggest hang-up with them is that I view them as wily expensive -- as are most "investments" available from insurance companies. Then again, maybe this is a misperception on my end and they aren't as expensive as I think.

Anyone have some words of wisdom on annuities for us all?

Comments

[Paul Williams @ Crackerjack Greenback]

FMF,

Your suspicions about annuities being wildly expensive are true. If you're not especially careful, you'll offset any potential benefits by going with a high fee annuity.

If you've maxed out your retirement plans, IRAs, and any other tax-deferred options, then an annuity might be a good choice for more tax-deferred growth. Like you said, look for low-load or no-load annuities (I'd go no-load myself). Vanguard has some annuity options but I haven't looked closely at them. Another possibility is Ameritas Direct. You'll just have to look around.

I'd reiterate and strongly emphasize the point in the article about annuities being useful ONLY AFTER you've maxed out all other tax-deferred options. I have a feeling that many people with an annuity haven't actually done this and only own the annuity because a very smooth salesman talked them into it. That's the very reason why annuities have such a bad rep.

[Sarah]

As far as I can see, the only real reason to buy an annuity (fixed) is at retirement, to convert some of your portfolio into a vehicle that offers a guaranteed rate of return.

[Paul Williams @ Crackerjack Greenback]

@Sarah:

You can choose to take the income stream (annuitize) or not. If you choose not to, then an annuity could be used to grow your money tax-deferred. It works like a Traditional IRA only without the initial tax deduction (plus higher fees).

[Mr. ToughMoneyLove]

A single premium fixed annuity can be appropriate for a retiree with low tolerance for risk, a small SS benefit, and no pension. The key is to keep some money in reserve for non-recurring costs. Even though annuities are costly compared to other investments, the peace of mind it can buy the nervous retiree also has value.

[Thankful]

I'd agree that annuities are only an option to consider after fully funding all other retirement vehicles, and then only in certain circumstances. However, certain annuities can be a wonderful option for people with very large estates who want to leave money to a large number of people. It can allow you to leave money to people without it being considered part of your estate since you can name a direct beneficiary. Might be a great idea for anyone who has explored every retirement option already and is in more of an estate planning mode.

[Paul Williams @ Crackerjack Greenback]

@Thankful:

From an estate planning perspective, there are much better options for leaving part of your estate to many different people. For people with large estates you could look at a family limited partnership or LLC to get an additional discount so you don't pay as much in gift taxes. You could also use irrevocable trusts or just outright gifts.

You'd also have to be very careful using an annuity for this as any incidents of ownership would still cause it to be included in your estate. If it has a named beneficiary then it won't be subject to probate, but if you have any control over it whatsoever when you die then it will probably be included in your taxable estate (which is the bigger issue).

[Tarah]

I can't speak for variable annuities, but I actually sell fixed annuities. Some companies have annuities that are very costly and do a good job at locking up your money (not a good idea). These are the annuities that give them a bad name.

The ones I sell have no fees, have a 5-10 year penalty period during which time you can access 10% per year penalty free. After the penalty period, you can access anything, no loads or fees. The fixed accounts are either a percentage that locks in (like a CD except 2-3 times as much interest), or Equity Indexed (when the S&P 500 goes up, so does your account. When the S&P 500 goes down, your account doesn't.).

Every company has different ones, these are the ones I know because I sell them. I think they are a personal choice, it depends on your situation as to whether they're a good idea for you. As with anything tax-sheltered, there are tax penalties if you take out any money before 59 1/2. Most people don't annuitize their annuities, they just treat them like any other investment. It usually isn't a good idea to annuitize them unless a person has to go onto wellfare because an annuity is still somewhat liquid.

[aa]

I have been maxing out 401k and IRA and would rather invest extra in my taxable account instead of an annuity.

[Bob MacDonald]

There is one very important point about annuities (fixed annuities not variable) that the post and comments failed to highlight. The return of principal in fixed annuities is guaranteed. Fixed annuities may offer a low rate of return, but that return is guaranteed. In light of today's environment, I wonder how many individuals who "maxed out their investments," would be happy if they could go back and put their funds in "boring" annuities? When an individual is facing retirement and has a lump sum of capital I would argue the annuity is the first investment, not the last. Annuities can be effective in providing a "safety-net" or reserve and income. Once that base of income is established then the investor is free to go hog-wild on risk investments.

[enlarge penis]

hello webmaster! i am really appreciating you for your kindness that you have made a really interesting blog and pick all the great topics for which peoples are always seeking to get information and share their ideas. Great work Man and keep it going. God bless you!

[enlarge penis]

hello webmaster! i am really appreciating you for your kindness that you have made a really interesting blog and pick all the great topics for which peoples are always seeking to get information and share their ideas. Great work Man and keep it going. God bless you!

[penis enhancement]

This is one of the best blog, i have ever seen in my life, really impressive work by webmatser, i must wanna share my views about this posting, that very low rang of people talk about this in public forum so hats off to blogger. thnx.