Fixed Deferred Annuities Provide Security
If you visit a bank for information about a certificate of deposit nowadays you are just as likely to get an earful about deferred annuities instead. As interest rates have plunged to their lowest levels in 40 years, banks have been promoting these insurance products as a better alternative to CDs. But while annuities may be a good choice for many investors, they're not for everyone.
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What is a Deferred Annuity?
A deferred annuity is a contract with an insurance company. Deferred annuities are a common retirement savings tool because you don't pay taxes on earnings until you withdraw the money. At that point, you usually have several options, such as a lump payment or immediate annuity payments for as long as you live.
Two Types of Deferred Annuities
Deferred annuities come in two categories: fixed or variable. During the stock bull market, variable annuities were popular because they let policyholders choose among a number of investment options, such as stock mutual funds. These days, fixed annuities are in the limelight.
Fixed Deferred Annuity Contract Choices
With a fixed deferred annuity, the insurance company guarantees that it will pay no less than a minimum interest rate. But with some contracts you may earn more. Some companies offer a bonus rate the first year and after that the rate drops off.
Most annuities have surrender charges. That means policyholders will be penalized if they withdraw all or part of the money before the surrender period ends. For example, the surrender fee might be 5% in the first year of the contract, 4% the second year and so on until it disappears in year six. The formulas vary, and you need to get the details. Some fixed annuities let you withdraw a certain amount, such as 10% a year, without penalty. Others may waive the surrender fees if you die or have a terminal illness. Many states give you a certain number of days after you buy an annuity to return it; allowing you a period to review the contract while retaining the option of getting your money back.
Who Benefits most from Fixed Annuities?
Fixed deferred annuities are clearly for people who want predictability - those who can't stomach the ups and downs of the stock market. Many people who buy fixed annuities aren't seeking a long-term commitment. They may already be retired and just want an alternative to a CD -- a safe place to earn a decent return.
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Annuities offer one thing that CDs don't -- tax deferral. That means consumers in high tax brackets reap the most benefit. But fixed annuities, like CDs, are not liquid. So consider other options if you will need the money before the surrender period expires. Older consumers should think twice before locking up money in a long-term annuity.
There are pitfalls for younger people as well. If you're 45 and buy a fixed annuity thinking that you'll withdraw the money at the end of a seven-year surrender period to use for a down payment on a vacation home, think again. In most cases, you can't tap into an annuity before age 59 1/2 without incurring a 10% penalty on top of taxes on the earnings. Keep in mind that a fixed annuity is not FDIC insured. Each state has an insurance guaranty association that is designed to protect policyholders. Most states will protect up to $100,000 in fixed annuity benefits, but policyholders may have to wait to get their money after their insurer goes belly up.
Always Research a Fixed Deferred Annuity Purchase
Just as you wouldn't buy the first TV you see, if you decide a fixed annuity is a good investment, don't simply accept the first one that someone tries to sell you. Shop around for the best product. There are some simple tips for smart shoppers. Start by reading the NAIC' s helpful brochure, "A Buyers Guide to Fixed Deferred Annuities."
You also can consult an insurance broker who represents many companies. He will help you assess your needs and provide you with the best products available from their stable of insurers. When you've narrowed your search to a couple of annuities, check out the safety ratings of the insurance companies. Make sure they get one of the top scores from the ratings agencies. These agencies include Standard & Poor's, A.M. Best, Moody's and Weiss Ratings.
Never buy a financial product if you don't understand how it works. Ask questions; if the person trying to sell you an annuity can't explain a product to your satisfaction, find someone who can.