Annuities are a series of regular income that investors receive at once or at some point in the future. To receive annuities, investors should sign a contract with an insurance company and make either a lump-sum or series of payments.
There are three main types of annuities: fixed, variable, and indexed. Each of them has its own level of risk and payout potential, but the incomes are all taxed at regular income tax rates.
What are the pros and cons of annuities?
- Investors can enjoy tax deferral of investment gain until they withdraw funds as in a traditional IRA.
- Investors can change their investment directions at little or no cost.
- Investors can gain regular flow of income for the agreed-upon period which could last for the rest of the investors’ life or their spouses’ life.
- Investors can have asset protection. In certain states including Texas, Florida, and New York, annuities are protected from creditors and lawsuit plaintiffs.
- Investors can have a stable and predictable income stream since they are well aware of their rate of return for a certain period of time, especially fixed annuities. This one is especially attractive to senior investors and during a recession.
- Investors will face tax penalties in they wish to withdraw money from the fund before they reach 59½, which will generally cost investors 10% or more.
- Investors will face surrender charges which ranges from 0%-8% for the first 6 to 8 years if they need to withdraw their money early, making their assets lack of liquidity.
- Investors will have to pay higher sales commissions compared with mutual fund and CDs.
- Investors’ net returns will be taxed as ordinary income (37%) instead of long-term capital gains (20%) if they withdraw their money.