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Pros and Cons of Annuity Products

Annuity products offer many different guarantees.  The different types of annuities have different features and options to help you meet your own personal financial goals.  Some guarantees work great for one person, but are not right for another person.  In “Differentiating Annuity Guarantees,” The Ledger’s Chas. P. Smith offers up the pros and cons of fixed annuity, variable annuity and indexed annuity guarantees.  Keep in mind that the benefits of any type of investment always come with a cost.  You must do your due diligence or work with a financial professional to determine whether the costs associated with any product are worth the benefits received in your individual financial plan.

Fixed annuities guarantee a stream of income.  It can last for a specific number of years, over your lifetime or over you and your spouse’s lifetime.  These guarantees are backed up by the insurance company selling the annuity product.  Most fixed annuities also offer death benefits that are payable to your heirs.  The death benefits equal your original investment minus any withdrawals that you already received.  While taxes are deferred in annuities until you start receiving payments, you will eventually be taxed on your withdrawals at ordinary income tax rates.  Not all fixed annuities offer inflation protection.  Annuities are not liquid investments.  It is rarely worth the penalty to take money out of them early.  The current low interest rate environment makes fixed annuities a little less desirable than when interest rates are high.  All of these cons are put to rest though when you use only a portion of your savings to purchase a fixed annuity.  You can meet the other goals elsewhere, but a fixed annuity is one of the only ways to guarantee yourself an income stream.

Variable annuities offer the potential to take advantage of market upswings by keeping your money in stock and bond mutual funds within the annuity.  They also protect against some market downswings.  Many variable annuities contain a guaranteed income rider which allows you to choose the date that you want to activate your guaranteed income stream.  Variable annuities can have high fees, so make sure that you are aware of these from the start.  Similarly to fixed annuities, variable annuity gains are taxed as ordinary income rather than the lower capital gains tax rate.  Your annuity value and rate of return are usually not guaranteed.  While this is seen as a con to some people, the market upside potential is worth this drawback to many others.  That is why you have to do a cost/benefit analysis of any investment.  Variable annuities do not step up in basis when the owner dies.  You will be penalized if you take your money out before age 59 1/2.  The illiquidity at a young age is similar to that with fixed annuities and an important reason to diversify.

Fixed indexed annuities link your return to a particular stock market index.  Many indexed annuities will lock in your guarantees from one year to the next.  One of the major benefits of fixed indexed annuities is that you are protected in the case of market downturns.  The volatility protection is worth the costs for many people.  With indexed annuities, insurance companies often put caps and participation rates that may limit the amount of gains you receive.  Surrender periods are often longer than with other annuity products.  Similarly to variable annuity products, there is no step up in cost basis at death and income taxes are higher on your gains than with some other investments.  The bottom line with all of these annuity products is that they offer guarantees that are unmatched with other investments.  There are costs that come with these guarantees as well.  Many people who research annuities find that the costs are worth the benefits they will receive, especially when it comes to guaranteed lifetime income.

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