Annuities: Part I
In today’s volatile climate, investments seem to be wading in uncertain waters. Even one-time solid choices like blue-chip stocks are swimming in rough seas. Because of this, investors sometimes examine a myriad of possibilities to secure or help their money grow.
So what are annuities? They are products that take the form of insurance contracts. How do they work? Essentially, the investor gives an up front amount or periodic payments to the insurance company. In return for the payment/s, the insurance company allocates the investor an income. The income can be deferred, start immediately, be paid out in intervals (e.g., monthly) or even be assigned in one lump sum; there’s a lot of flexibility regarding distribution.
Annuities fall in to two categories: fixed and variable. Let’s briefly look at both.
- Fixed Annuity. Fixed annuities have a type of certainty attached to them in the respect the investor has a firm grasp on both the minimum interest rate and the dollar amount he or she will receive. In this situation, the insurance company makes the investment decisions. Fixed annuities are often referred to as guaranteed because the insurance company assures the investor he or she will be paid a fixed income independent of asset performance.
- Variable Annuity. Variable annuities differ from their fixed brethren in that the investor makes the decision where to put the money: mutual funds are a common choice. Because the investor is in control, the insurance company does not guarantee the income amount. Because of this, income varies, often dictated by how well the investment is performing.
Okay, what’s appealing about annuities? Well, they’re certainly not for everyone. However, for the right individuals (e.g., those who has the cash to invest), they have benefits; in particular, they allow for money to be tax deferred. Therefore, the payment the investors put in, and the interest that accumulates, need not be declared to the IRS until an income is drawn. By that time (typically retirement age), people are usually in a lower tax bracket.
And negatives? There are a few.
- Annual fees. Fees can be high, mainly in variable annuities.
- Commissions. Brokers authorized to sell these products generally make a healthy commission.
- Surrender penalties. An investor who wishes to cash out of the investment, especially if the decision takes place shortly following the product purchase, will face substantial charges to do so.
This all sounds confusing? It can be. A trusted financial advisor or investment expert should be consulted before an investment of this nature is made. Next week we will look a little more closely at annuity income and an optional attachment available on some annuity products called Guaranteed Lifetime Income Rider (what?). Until then, though, think spring!