An Investor’s Guide To Annuities

Chances are if you are looking at planning for retirement, you have come across annuities as a potential investment product for retirement income. The proper annuity may enhance your investment portfolio, but it is important to make sure it is suitable for you.

What is an annuity?

An annuity is a contract between you and an insurance company that pays out income over time. In exchange for a lump-sum or series of payments, the insurer will make periodic payments immediately or at a future date. Money in an annuity grows tax-deferred until withdrawal and may offer death benefits for your beneficiaries. Given the numerous types of annuities, it can be difficult to select the right one. In shopping for an annuity, there are three choices that you will have to make:

1) Liquidity. Most annuities are illiquid and have a steep surrender charge if you withdraw your money early. The typical surrender period can be anywhere from five to 10 years. Make sure you do not need to use the money you put in an annuity during that time period.

2) Timing of payout. You can choose to have your payments immediately or deferred. In an immediate annuity, you will receive payments immediately upon investing. This is for those who need immediate income from their annuity. In a deferred annuity, you receive payments starting at a later date, usually at retirement.

3) Type of investment. How much you receive in payments can depend on the type of annuity: Fixed, Indexed, Variable. Fixed annuities give a guaranteed payout over a certain period of time. Variable annuities are tied to the performance of the stock market or a selected group of investments. Your payout amount will vary based on the investment options selected. Indexed annuities have characteristics of both a fixed and variable annuity. It gives guaranteed payments combined with a return based on a specific market index.

Is an annuity right for you? Generally you should consider annuities after you have maxed out your other qualified retirement plans such as 401(k)s and IRAs. If you have additional money, you can take advantage of the annuity’s tax-free growth, especially if you are in a high tax bracket. Annuities do not have a limit on investment amount. Because annuities tend to be illiquid, make sure you do not need to use the money during the surrender charge. Annuities also can have fees.

Make sure that you are comfortable with them and compare this with other similar types of investments. Sometimes an agent will push one annuity over the other because of the commissions. Do your homework so you choose the annuity that is right for you. It is also important to understand withdrawals will be taxed at your ordinary income tax rate. When shopping around, understand the differences between annuities and make sure the company you purchase the annuity through has a high rating with a long history.