What are Annuities?

Annuities are currently being sold by Financial companies as an excellant retirement product and it is important to understand what these products entail and the types of annuities available.

Definition:
"An annuity is a contract between you and an insurance company, under which you make a lump-sum payment or series of payments,(monthly usually). In return, the insurer agrees to make periodic payments to you beginning immediately (known as Immediate Annuitization) or at some future date."

Features of an Annuity
Annuities typically offer tax-deferred growth of earnings and may include an option to purchase a death benefit that will pay your beneficiary a guaranteed minimum amount, such as your total purchase payments. As such, the Variable Annuity is a more complex product and offers the most option or features. Each feature or option of an annuity has a cost factor attached that is charged to your Contract Fund. Hence,the more options chosen the higher the management fees or operating costs for these funds.

Types of Annuities
There are generally two types of annuities—fixed and variable.

Fixed Annuity
In a fixed annuity, the insurance company guarantees that you will earn a minimum rate of interest during the time that your account is growing. The insurance company also guarantees that the periodic payments will be a guaranteed amount per dollar in your account.

These periodic payments may last for a definite period, such as 10, 15 or 20 years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.

Variable Annuity
In a variable annuity,the investor can select to invest your purchase payments from among a range of different investment options, typically mutual funds. The rate of return on your purchase payments, and the amount of the periodic payments you will eventually receive, will vary depending on the performance of the investment options you have selected.

Advantages of Annuities
1.Since this is contractual obligation with guarantees, it is an excellant choice of a retirement product that offers guaranteed payments and offers security of the principal investment.

2.The variable product offers savy investors the safety and the investor an opportunity to participate in some gains from the stock market, with limited downside risks due to the minimimum guaranteed returns.

3.There may be a significant initial signing bonus for an immediate lump sum payment into an Annuity. This will significantly increase your rate of return.

4.All earnings grow tax-deferred, that is the earnings accumulate tax free and are only taxed at time of distribution or annuitization process.

5. Clearly, this annuity investment (tends to over the life of the annuity), offer greater rates of returns than if the funds are invested in a fixed CD say for over 7 years.

Risks and Disadvantages
1. This is a very complicated product and requires highly trained professionals to explain the features and options of each product.

2. The management fees or costs attached to the annuity are significantly higher than conventional mutual funds.

3. There are hefty surrender charges if the contract is not maintained for a minimum duration of 7 years. This is longer than the normal Class B shares of a mutual fund, although the surrender %charge declines on an yearly basis starting as high as 7% and declining to 1% in year 7. Each Annuity has its own unique features and the surrender charges may vary slightly.

4. During the time of annuitization, (Payout Option), if the wrong option is selected, investor may not outlive the payment period and could lose his investment. Hence, additional options are selected that gurantees a period certain say 10 or 15 years to the beneficiary in case the investor does not survive the period certain time of say 10 or 15 years.

5.This product sale offers some of the highest compensation in terms of agent commission to financial professionals. So, it is touted as the best product by all the financial professionals and you can read and hear a lot in the media about these products. Just be aware these products are not cheap and are not for everybody.

In any case, I would strongly advise that you consult your financial advisor or CPA to determine if these products meet your retirement goals and objectives.

__________________
Find a CPA near you!

Ask TaxGuru Please refer to the legal disclaimer.