Annuities can be appealing investments to the right investors, but like any investment vehicle, there are advantages and disadvantages to using them. Annuities are not complicated and are pretty straightforward when calculating earnings, making them a popular choice among investors. However, some of the particulars of the investment vehicle means that it could end up costing the investor, and their estate, much more than they ever receive in benefits. Here are some of the things you should know about the advantages and disadvantages to investing in annuities.
Types Of Annuities
There are two basic types of annuities to choose from. Immediate annuities begin paying you as soon as you purchase them and can be set to distribute payments over a set amount of time, typically 5 to 20 years, or to distribute payments for the remainder of your life. The rate of return on immediate annuities depend on a number of factors, including your sex and your age when the annuity was purchased. Deferred annuities delay payments for months or years, so contributions to can be made in several payments instead of one lump sum.
There are also two ways used to calculate the earnings from the annuity. Fixed annuities have earning rates that are guaranteed for the life of the annuity, resulting in regular payments of the same amount for the entire term. Variable annuities have earnings that fluctuate based on the performance of the underlying investment portfolio, which means that any payment could be higher or lower than the one before. However, variable annuities typically have a guaranteed minimum payment, so the investor can depend on getting at least that amount in each payment.
Advantages To Investing In Annuities
Annuities are an attractive investment vehicle because the interest and earnings grow on a tax-deferred basis. If an annuity is scheduled to begin payments after you retire, the tax savings can be substantial because your income and your tax rate will be lower. If you have maxed out your contributions to your 401k or IRA retirement account, you can save additional money for your retirement years by investing in an annuity.
Disadvantages To Investing In Annuities
The biggest disadvantage to investing in annuities is that any undistributed proceeds present after the death of the annuity’s owner revert to the insurance company, not the beneficiaries of the annuity owner’s estate. While some annuities will allow you to name a beneficiary, that beneficiary is bound by the same terms that you agreed to when investing in the annuity. Your beneficiary will also lose the tax advantages because inherited annuities are taxed on both interest and principal. If your beneficiary also dies before the end of the term, the undistributed proceeds revert to the insurance company.