I was watching TV over the weekend when a commercial came on about annuities. The commercial made it out that annuities were the best things since sliced bread, claiming that you could not lose money with them and they were an investment everyone should have, particularly in retirement. Like most commercials, there was some truth in it, but it did not tell the whole story. In many situations, annuities are aggressively marketed and that alone should give people cause for concern. After all, when it comes to investing, you don’t want to be sold something that doesn’t fit your situation. I thought I would take this opportunity to talk a little bit about annuities, pros and cons.

Basically, there are three types of annuities: fixed annuities, variable annuities and immediate annuities. Fixed annuities and variable annuities have the benefit of income growing tax-deferred. You only pay taxes when money is withdrawn and, at that point in time, it is taxed at your ordinary income bracket. Although tax deferral can be a benefit, it also can be a problem. When money comes out of an annuity, it’s taxed at your ordinary income bracket, which is your highest tax rate. Annuities don’t qualify for the favorable capital gain treatment, so it is possible that by deferring your taxes, you are actually raising them, defeating the purpose of an annuity.

The returns on annuities depend upon the type you purchase. In a traditional fixed annuity, you get a guaranteed rate of return. Currently, traditional fixed annuities are paying about 2 percent. An index annuity is also considered a fixed annuity, but your return is based upon an index that you select — typically, stock-based indexes. The nice thing about these types of annuities is if the market goes down, you don’t lose money. It is important to keep in mind dividends are not figured into the equation and most index-based annuities do not give you a 100-percent participation rate. If your participation rate is 60 percent and the market went up 10 percent, your return would be 6 percent.

One of the problems with index-based annuities is that they are very complex and sometimes very difficult to understand. If you end up buying an index-based annuity, it is important to learn about them and then to shop around. There are tremendous differences with regard to fees on these annuities.

Variable annuities are ones that allow you to invest in, typically, mutual funds. Your return is based upon the funds you select. The problem with variable annuities is if you held these investments outside the annuity, they would be subject to capital gain treatment vs. ordinary income. In addition, just like with the fixed annuities, you typically have to lock your money up for a period of time. It’s not unusual to see variable annuities with a 10-year penalty period, which means if you cancel the annuity before 10 years, you lose some of your money. In addition, variable annuities tend to have very high administrative and investment fees.

An immediate annuity is a different animal all together. An immediate annuity is similar to buying a pension for yourself. In an immediate annuity, it guarantees a certain amount of money for the rest of your life. No matter how long you live, you’ll get a regular paycheck. For many people, this is a very comforting investment. The downside is once you’re in an immediate annuity, you cannot cancel it — it’s an irrevocable investment. Just like with fixed and variable annuities, it does pay to shop around. Not all companies are the same.

In certain situations, annuities make sense. They are not for everyone and certainly no one should be pressured into purchasing one. If a salesman is overly aggressive, simply walk away. Because annuities are generally long-term investments, you need to take your time and shop around.

One last note: If you are looking at a variable annuity, you want to make sure you look at companies like Fidelity, Vanguard and Schwab. They all offer low-cost annuities without penalties. You have greater flexibility in the fact that you can withdraw your money at any time without penalty.

Good luck!

by Rick Bloom | May 25, 2017

 

Author: Rick Bloom

Source: Observer & Eccentric Media

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