What is a annuity?

annuity

Annuities are insurance contracts whose payments are guaranteed by the company issuing the contract; and can be used as part of a retirement strategy, or a long term investment.

Everyone in today’s world wants to have financial security. The timeless adage, “money makes the world go around”, never goes out of date. Everyone wants financial security and annuities are a viable option in today’s financial market.

How does an annuity work?

When you invest in in an annuity you are buying a future revenue stream.  When you buy an annuity you know that you will get a certain amount of money at certain times during a certain time period.  The payments might be weekly, monthly or yearly etc. The seller of the annuity guarantees that you will get these payments.   Annuities are therefore a popular alternative for people who wants to know that they will have money coming in no matter what happens.

Annuities are very bad investments and the money you get out of them during their maturity is a lot less then you would get if you invested the money in something else. They are extremely profitable for the companies offering annuities and they pay financial advisors very high commissions to get them to recommend annuities to you despite them being a bad investments.  It is common that the advisor gets 4% of the purchase price or more as a commission.  This allows them to make a lot of money since annuities usually are rather expensive.

You can choose to receive payments for the rest of your life, or for a set number of years. How much you receive depends on whether you opt for a guaranteed payout sled a fixed annuity, or a payout stream; determined by the performance of your annuity’s underlying investments called a variable annuity.

What are the advantages and drawbacks of an annuty?

Annuities can in some case offer some tax benefits but the drawbacks usually outweigh the benefits and I recommend against investing in annuities.

Pros

If you’re someone who can make an investment and not make early withdrawals they are the perfect investment. They are good investments for people who are good with their finances, and financial planning.  You know how much money you will get and when.  There is no risk or uncertainty involved.

Cons 

If you make a withdrawal within the first five to seven years you typically will be hit with surrender charges up to 7% of your investment, or more depending on your investment purchase. They are a very expensive way to invest, they often charge high fees and the return you get is a lot lower then what you would get if you invested in dividend stocks or a number of other investments.  This is especially true since many annuities want start paying you money until many years in the future.

Types of annuities

What’s an income annuity?

Income annuity provides guaranteed income in your retirement plan.  You pay to know that you will get a certain amount each month when you retire.  You will get money for a certain number of years or for the rest of your life.  You have the flexibility to choose how much income you need and when you’d like your payments received. These annuities are very expensive compared to what they offer if you consider the effect of compound interest.

What are the advantages of an income annuity?

You know that you will get money and do not need to feel financial insecure.  You can not make a mistake and lose the money.

What are the disadvantages of income annuty?

They are an extremely expensive way to save for your retirement. Investing the same money in dividend stock will usually give a lot better result and a lot higher income when you retire.

What’s a variable annuity?

This type of annuity is a long term investment that offers:

Similar to an IRA, a variable annuity lets you save for retirement, and defer paying taxes on your earnings until you make withdrawals. By deferring taxes, you can increase compounded earnings growth, and potentially end up with a bigger lump sum for your nest egg.

What are the advantages of a variable annity?

  • Deferred taxes on earnings until withdrawn
  • The ability to receive payments
  • The option to pass assets to beneficiaries

Key advantages to ask about when searching for a variable annuity

  • A range of portfolios, which are similar to mutual funds
  • Returns vary depending on the performance of the selected portfolios
  • Tax-free exchanges among investment portfolios
  • Death benefits payable directly to beneficiaries, avoiding the delays and costs of probate court
  • No tax limit on contributions

*No tax requirement to start withdrawing money after you turn age 70½, if you bought your annuity with non-qualified (after-tax) assets.

What are Disadvantages of a variable annuity? 

Variable annuity are more expensive to use then other saving plans like IRAs, and 401(k) plans. They  often have large penalties if you want to withdraw money early.

These investments must be held for many years to allow time for the tax deferral benefit, to outweigh the higher expense. Variable annuities also carry an investment risk.

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