All Annuities are Insurance Products, but they are Not All Created Equal
I would like to know the difference between a variable annuity and a life annuity. A few years ago I invested $100,000 in a tax-deferred variable annuity. Later, I found out there is a surrender charge for seven years. Is a life annuity tax-deferred? Is there a surrender charge?
Many people get confused about annuities because the same word applies to many different insurance products.
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The most basic type of annuity is the functional equivalent of a CD issued by an insurance company. You make a commitment for a fixed period of time and receive a stated amount of interest, tax-deferred and guaranteed by the company.
These annuities provide a variable fixed-income return that depends on a complicated formula. Unlike equities, the value will never decline, but you don't get the dividends equities pay. The formula also generally sets a significant limit on the upside in good years. These products carry high commissions, which is one of the reasons they are sold with such enthusiasm. They should be avoided.
A VA allows you to assemble a portfolio of mutual funds or investment sub-accounts inside an insurance contract that provides tax deferral for interest, dividends, and capital gains. The contract can also have options that provide for a guaranteed withdrawal amount. As I have regularly shown in the "Annuity Watch" feature on my website, however, the costs of variable annuity products exceed the value of any tax-deferral benefits. There are simple alternatives that provide better income solutions.
We had heard about annuities and were investigating them for our IRAs. We also heard bad things about pushy brokers over the years. So when we went to the ImmediateAnnuities.com site we were skeptical about calling them. But whenever we called their staff was really friendly. They answered all our questions and one of their reps even told us that at our ages there was no advantage to buying the annuity with our IRAs. These guys are really honest!
These are insurance contracts in which you give up your principal in exchange for a guaranteed lifetime income. A portion of your monthly check will be considered return of principal and won't be subject to taxation. The income can be guaranteed for your life only, your life or 10 years (whichever is greater), or for your life and the life of your survivor. The most common way most people get life annuities is through a company pension. Social Security is a life annuity.
Relatively few people buy life annuities directly because they worry about getting their "money's worth" - receiving more in payments than they have paid into the contract. While some people will receive less and others will receive more, life annuities have great value in retirement planning. I believe they will be used more frequently as fewer people receive pensions and more workers depend entirely on their qualified plan savings for retirement income.
Which annuity products are most useful? CD-type fixed-income annuities have many uses. So do life annuities. I find little to justify the existence of both variable annuities and equity-index annuities.
Source - boston.com - 09-13-2008