What exactly is an annuity? There are two broad categories for the Annuity buyer: Deferred and Immediate. Both are financial contracts you make with an insurance company. However, a typical deferred annuity helps you accumulate money, while an immediate annuity provides you with an income stream in return for your purchase. Although you put money into both types of annuities, the difference is when you start receiving money from them. Just as the names imply, you get money soon from an immediate annuity and you delay getting money from a deferred annuity.

 

If you invest in a deferred annuity, you can fund it with regular contributions or a lump sum. The money is then invested in various sub-accounts depending on the investment criteria you and your financial advisor choose. Within a "variable annuity" are several investment options to diversify your portfolio. These can include bond funds, equity funds, real estate funds, international funds, and fixed (guaranteed) accounts.

With a "fixed annuity" you can have a guaranteed interest rate for a specified period. For example, you may purchase a fixed annuity that pays 5% over the next five years.

There are some advantages that come with investing in annuities. The contributions grow tax-deferred which means that you don't pay taxes on the growth over the years as it goes in value until the time you begin to withdraw money. In a regular non-retirement account you would have to declare the interest as income annually and possibly have to pay taxes on the interest earned.

Beneficiary protection is a huge draw to annuities as they can offer guarantees for your loved ones in the event of your passing. Some guarantees include a "stepped up" provision which allows the beneficiary to receive the highest amount or value that the account has reached despite the actual value the day of the death of the owner. And since annuities avoid probate this is an even bigger bonus for your beneficiaries.

The annuity also allows for an income stream to you when you are ready such as at retirement with their different payout options. At this point you would be annuitizing your investment and you would no longer be able to contribute to the account. Instead you could receive a fixed income stream which you could never outlive. Most annuities have a lifetime payout option. There are also options for a guaranteed period of time such as 10, 15, or 20 years for the owner and an option joint life and survivor.

Many variable annuities now come with a "living benefit" which insures that you will not lose your principal. These benefits come with a couple of catches. The first catch is that these benefits have a cost (typically .3% - .5% of the asset value). The second catch is that you are limited in the amount of money you can withdraw from the contract each year (i.e. 7% per year). These guarantees can be ideal for an investor that is really concerned about losing his or her principal. If you can live with the drawbacks, it may be a good plan for you.

There is not a "one size fits all" answer when it comes to annuities or for any financial planning for that matter. Before you decide to invest in anything, make sure you contact your financial advisor.


Steve Scalici, CFP® is the Vice President of Treasure Coast Financial, a financial planning firm in Stuart, FL. He is co-host of God's Money which can be heard weekdays at www.oneplace.com. He can also be reached at his website www.tcfin.com.