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There are two different types of annuities: deferred annuities and immediate annuities. The type of annuity you choose depends on how soon you expect to receive payments. If you are looking for a long term investment where you plan on making withdrawals once you reach retirement then you might choose a deferred annuity. If you are looking to make withdrawals sooner than you may want to choose an immediate annuity.
English: Types of Annuities (Photo credit: Wikipedia)
Either type of annuity can be fixed or variable. A fixed annuity acts like a CD from a bank but in this case it is an investment with an insurance company. You have a fixed interest rate that you receive for the annuity and it is usually a higher percentage than a normal CD would bring at a bank.
The guaranteed interest payment from these fixed annuities as well as the minimum amounts that you have to invest makes the fixed annuities appealing for those who are not confident in the ways of the stock market.
Another nice thing is that you do not have to pay taxes on the interest gained until you decide to start withdrawing the money from the annuity. A disadvantage with fixed annuities is that the interest rates might be high to begin with but can drop after the first year of having the annuity. This unknown factor can be a turn off for some who are hoping that they can maintain the rates that they first received when they started their annuity.
If you do not like the new rates and want to withdraw your annuity before it matures then you might be stuck paying surrender charges that will cut into your profits. With a variable annuity you can choose from a variety of investments to put your money into and the rate of payment you receive depends on how well the investments performed. With variable annuities you invest in several different stock or bond like accounts that will help your investment grow over a long period of time. Just like with the fixed annuities you pay no taxes on your gains until you begin withdrawing from your account.
Although with variable annuities you may have an opportunity to have greater growth potential with your investment there are some drawbacks as well. The investments you chose may take a turn for the worse causing your potential growth to plummet. There are drawbacks with the tax rates when you decide to withdraw you money,as well as fees if you decide to withdraw early and there can be high sales commission fees. It is good to do your research before you decide which annuity is best for you or even if an annuity is a good investment.
The truth is that annuities can be a very good investment for the average person. The advantages to investing in annuities definitely outweigh the risks.
Many people think that annuities are a bad investment because they think that annuities only pay a fixed return. This is only true if a person buys a fixed annuity. There are a wide variety of annuity products that offer a variable return comparable that on mutual funds. These include variable annuities and indexed annuities.
Others think that annuities are a bad investment for average people because they have to be purchased immediately in one lump sum. That is not true because there are many deferred annuities that can be purchased gradually like other investments. A person can make payments into an annuity just like any other retirement investment. If you decide to go with a fixed annuity, lock in your fixed annuity rates early as rates tend to fluctuate.
Another common mistake is the idea that annuities are insurance policies. Annuities are not insurance policies, annuities are an insured investment. This makes annuities a really good investment for a working person because the funds placed in the annuity are insured. A person who purchases an annuity will get the funds placed in it back. Almost no other investment available today will guarantee that.
Others think annuities are bad because the insurance companies that issue them can go out of business. There is some truth to this but most people don’t realize that annuities are guaranteed by state governments. Most state governments insure annuities for up to $100,000 and some states insure annuities for up to $500,000. That means the average investor should be reimbursed even if the annuity company goes out of business.
It should also be pointed out that when AIG, a huge company that issued a lot of annuities; got into trouble it was bailed out by the federal government. This means that there is little possibility that funds in annuities can be completely lost the way funds in some investments can be.
Annuities and Taxes
From a tax point of view annuities are not a bad form of investment. Any funds that are placed in an annuity are tax deferred this means that they are not taxed.
Annuities that are used as retirement savings vehicles are subject to the same IRS regulations as other retirement plans. This means that a person will probably pay a 10% tax penalty if he or she takes the funds out before age 59½. As long as the funds are left in the annuity until retirement there should be tax complications.
Annuity Fees
Many people think that annuities are bad investments because of the fees. Any investment can come with high fees attached. The reason investors end up paying high fees is that they don’t read the paperwork before buying an investment.
Annuities are just like any other investment they come with a contract. The fees charged on the annuity will be laid out in the contract. A person should read the contract and pay close attention to any provision about fees.
It is also a good idea to take the contract and read it away from the person who is trying to sell the investment. Ask if you can take the contract home and read it there. Also try reading the contract over more than once. In many cases a reader can spot hidden provisions in a second or even third reading. A person can even get somebody else that they trust and respect to take a look at the contract. An honest salesperson should have no problem if a customer wants to look over an agreement before you sign it.
Never sign an annuity contract if the fees in it are excessive. Instead ask to see some other annuity products so you can compare the fees.
Annuities are not a bad investment for the average person. There are some annuities that are a bad deal but these can be easily avoided by careful and informed investors.
