Annuities provide guaranteed income to you during retirement. This guaranteed income replaces the need for you to manage your own investments. Some annuities, called deferred annuities, defer the payment of this guaranteed income. But, annuities may not be suitable for you. Understand the problems inherent in deferred annuities before you buy into these products.
There are two types of deferred annuities: fixed and variable. Fixed annuities invest in the insurance company's fixed interest general account. Variable annuities invest in the insurance company's separate account. The separate account consists of mutual funds. You choose the mutual funds you want to invest in and the annuity pays interest based on the performance of these funds.
The significance of deferred annuities is that they act like savings accounts with insurance companies. These accounts are long-term accounts, however. You have the option to keep the savings inside of the annuity for your entire life or convert the savings to monthly payments. You may also withdraw money from the account periodically up to certain limits set by the insurance company.
Deferred annuity maturity dates often span from one to 10 years or more. This means that if you need money from the account, you have very limited options for accessing the funds. Life insurance companies allow up to 10 percent free withdrawals per year from an annuity. Some insurers offer up to 20 percent. However, a penalty is assessed for any withdrawals that exceed these limits. Penalties range from a few percentage points of the amount withdrawn to 7 or 10 percent of the amount withdrawn in excess of the free withdrawal.
If you withdraw money from a deferred annuity prior to age 59 1/2, you will be assessed a penalty from the IRS of 10 percent of the account balance. Also be aware that fixed annuities pay guaranteed rates, but those rates are often very low. Rates mirror bank CD rates. Variable annuities charge many fees. Account management fees, annuity policy fees, mutual fund management and 12b1 fees all take away from the earnings of your variable annuity.
Consider a Roth IRA or a traditional IRA instead of an annuity. IRAs offer tax deferral like an annuity, but investment choices may be more than an annuity. You won't have the annuity's guaranteed income option. However, you may have access to mutual funds or fixed investments that pay more attractive interest rates with lower total fees.
- "Life Insurance"; Kenneth Black, Jr., Harold D. Skipper, Jr.; 1994
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007