*Note: This was written by a Yahoo! contributor. Sign up with the Yahoo! Contributor Network to start publishing your own finance articles.
Before you get caught up in the annuity frenzy make sure you know exactly what is being pitched. Remember that retirement investing is a lucrative business and, while we encourage anyone to make an honest living, don’t get sweet-talked into an addition to your retirement package that makes no sense. You would be wise to have a heart-to-heart with your financial adviser about the ins and outs of annuities before you take the bait.
What is an annuity?
An annuity is an insurance product where you can make a lump sum payment or series of smaller payments. The money that accumulates is tax-deferred, growing at a fixed or variable rate. There comes a point where periodic payments from the insurer begin and you get these for the rest of your life. Your beneficiary has rights to either the value of the annuity or the guaranteed minimum.
What types of annuities are available?
Fixed annuities ensure you won’t lose money by locking in a guaranteed rate of returns for anywhere from one to ten years, creating reliable fixed income. In a variable annuity your money in invested much like it is in mutual funds, meaning the chance for gain is greater, but the risk also increases. An equity-indexed annuity works like a fixed annuity but you’ll have more opportunity for accelerated earnings since it’s associated with an index such as the S&P 500.
What are the fees?
Your earnings are decreased with fixed and equity-indexed annuities by the inclusion of fees and commissions. Variable annuities have a number of fees deducted: mortality and expense fees to cover the insurance risk against paying lifetime income, around 2% for administrative fees and an annual contract fee, typically $25. The surrender fee for early withdrawal on all types of annuities averages 5.5% in the beginning.
What are the drawbacks?
You can’t take any of your money out until you are 59 ½ or you will be slammed with a 10% penalty on the earnings. A typical contract is seven years and you’ll pay out a surrender fee if you withdraw cash before it’s up. Most annuities charge 1% annually for the death benefit and your beneficiary gets the advantage only if you die after your account is below the minimum guarantee. While you are living, the earnings are taxed as personal income rather than at the rate for long-term capital gains.
Who should buy an annuity?
You should only invest in annuities if you already have alternate retirement plans, including a 401(k) or IRA since these have the same tax deferral advantages but without the fees. Buy them only for long-term investment – the early withdrawal penalties are not practical. If you can live without the money for at least 15 years, and you are 59-1/2 the benefits will outweigh the fees.
More from this contributor:
How I Funded My Small Marketing Business
10 Investment Strategies for Beginners
Things a Small Business Can Do to Avoid Overspending