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Are Annuities the Right Investment for Your Retirement?


Here are the basics of annuities that you need to know about.

Also to consider: By investing in an annuity, you're also investing in the company that issues it. That guaranteed stream of income is only as good as the financial stability of the company writing the contract.

As we all learned just a few years ago, insurance companies – even the biggest ones – can run into major problems.

Deferred annuities also share the same lack of liquidity as immediate annuities, and they also have some additional downsides.

While insurance companies market their tax advantages, there are four big issues surrounding those benefits:

Tax rate: When you start withdrawing money, the earnings (but not the principal) will be taxed at your ordinary income rate, not the lower capital-gains rate typically applied to investments held for more than one year, like stocks, bonds and mutual funds.

That can add up to big tax payments, especially for those in high tax brackets.

Tax-advantaged accounts: There are some financial advisers or insurance agents that recommend variable or indexed annuities for accounts that are already tax deferred, like IRAs and 401(K)s. That's absolutely unnecessary, because those accounts are already tax advantaged.

If someone tries to sell you a variable annuity to hold in a tax-deferred account, head for the exit.

Estate planning: When it comes to annuities and estate planning, proceeds from most deferred annuities don't receive a "step up" in basis (when an asset's value is priced at the higher market value at the time of inheritance rather the value at which it was originally purchased).

Other investments (like stocks, bonds and mutual funds again) do provide a step up in basis at the owner's death, which can limit tax liability for the heirs. Deferred annuities can't offer that benefit.

Fees: But the biggest con for this annuity type is the sky-high costs. Mortality and expense charges, administrative fees, fund expenses, charges for special features and the salesperson's commission can eat up 2% to 3% of your investment value every year.

Questions to Ask

If an insurance salesman or financial advisor brings up the subject of annuities, here are six questions you should ask right straight away:
  • What type of annuity is this, and why are you recommending it for me?
  • How much will I pay in the first year of the contract, and then how much in subsequent years?
  • What will be your first-year commission on the contract, and then what will you earn in subsequent years? (You want to understand the total costs, from "mortality and expense" charges to the admin fees.)
  • Have I already maxed out my IRA, 401(k) and other tax-deferred vehicles?
  • Should I tie up my money with this annuity? Will I have ample liquidity outside of it if I do?
  • How is this insurer rated by AM Best, S&P, Moody's, and Fitch?
If you're still considering annuities to secure income in retirement, make sure you weigh the potential benefits as well as the risks, and understand the complications of these saving vehicles before handing your money over.

Editor's Note: This article by Vanessa Richardson was originally published on MintLife.

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Twitter: @mint
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