Annuities are contracts that guarantee a steady income in retirement. They are purchased with a lump-sum payment or a series of payments, usually to a life insurance company, which invests the money.
Types of annuities
- Fixed annuities. These earn interest at rates established by the annuity company. Fixed annuities are not good hedges against inflation, let alone vehicles for growth.
- Variable annuities. These offer a number of different securities to invest in—primarily mutual funds—and thus have earnings in league with stock indexes.
- Immediate annuities. These begin distributions within a year of a lump-sum payment.
- Deferred annuities. These begin distributions at a future date specified by the owner. They can be either fixed or variable—most are the latter—and offer the same benefits as immediate annuities.
Pros and cons of investing in an annuity
- The great attraction of annuities is that they guarantee investors income for life and remove the headaches associated with investment management.
- The tax advantages of annuities, however, are minimal. Contributions are not tax deductible, and distributions are taxed. Only the earnings are tax deferred. Furthermore, when the annuitant dies, assets are subject to income and estate taxes. Last but not least, variable-annuity fees are high, as are penalty fees for premature withdrawal.
- If your investment plan is to be secure and/or comfortable, these investment vehicles should be components of your overall plan. But if your investment plan is to be rich, these vehicles should only be used to realize the secure and/or comfortable portion of your plan. If your plan is to be rich, you also need to consider investing in tangible things such as real estate, and you need to consider building businesses.
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