Annuities have become a popular investment tool in a retiree’s arsenal. Annuities have great appeal for the investor looking to mitigate the risk of losing a large portion of their principal when they need it most. But many people considering annuities don’t fully understand how they work. An annuity is a contract between you and an insurance company, designed to meet retirement and other long-range goals. You make a lump-sum payment or series of payments. In return, the insurer agrees to make periodic payments to you beginning immediately or at some future date.
Below are some important considerations that should be noted before purchasing an annuity contract:
1. Early Withdrawal Penalties
If you withdraw your money early from an annuity, you may pay substantial surrender charges to the insurance company, as well as tax penalties.
2. Type of Annuity
There are generally three types of annuities — fixed, indexed, and variable. Variable annuities are securities regulated by the SEC. An indexed annuity may or may not be a security; however, most indexed annuities are not registered with the SEC. Fixed annuities are not securities and are not regulated by the SEC.
3. Death And Taxes
Annuities typically offer tax-deferred growth of earnings and may include a death benefit that will pay your beneficiary a specified minimum amount, such as your total purchase payments. While tax is deferred on earnings growth, when withdrawals are taken from the annuity, gains are taxed at ordinary income rates, and not capital gains rates.
Remember, if you withdraw your money early from an annuity, you may pay substantial surrender charges to the insurance company, as well as tax penalties. Annuities aren’t suitable for everyone. As always, be sure to consult with an attorney or financial advisor before making investment decisions.
photo credit: Steve Snodgrass