The pros of owning an annuity are significant in a high tax bracket where their tax deferral is a major component to accumulating cash values. Many times the annuity rate is higher than most banks and money markets. And if annuitized annuities can generate life time income you can’t outlive.
The cons of owning an annuity can be significant. Liquidity is a concern. In general the longer the hold position the higher the surrender charge. Fixed interest rates that lock down long positions like the present 3.25% for ten years could be too long if rates go up over the next decade. Today’s five year rate is 2.95%. Is the extra 35 basis points worth it for double the time period?
Robert J Russell - Finalist for Broker of the Year 2015
Broker Owner, InsuranceAgentsSelling.com, United States (Most States)
Pros
Immediate annuities are, in my opinion, the most useful of the suite. For Americans who will not be retiring with a meaningful stream of pension income, immediate annuities offer that potential. Because an immediate annuity is purposefully consuming both interest and principal to create an income stream, the individual distributions are likely to be higher than anyone could justify taking from a balanced portfolio of investments, where maintenance of the principal balance is often the goal.
Fixed annuities allow an investor to lock in rates of return that are comparable to CDs, but likely for longer terms (whereas CDs are typically quoted in months, fixed annuities are quoted in years ranging from one to 10.) The most common are three, five and seven year fixed annuities. If (read: when) interest rates rise from abnormally low rates to abnormally high rates, it could be a wise time to allocate some of one's fixed income exposure to a fixed annuity.
And unlike a CD—the interest from which is paid out and taxed annually—the interest or gains earned in annuities are deferred until distributions are taken.
Many annuities promise some level of principal protection. Even in certain variable products (invested in equities), a portion of your principal or even future income may be guaranteed by the company.
The advantages of equity indexed annuities are, frankly, hard to find amidst the overly-simplistic marketing pledges shrouding their overly-complex underlying construction. ... Whoever sells you the policy will likely be going on a nice vacation soon—commissions on these products range into double-digit percentages. Additionally, you could suspend disbelief and allow yourself to think you're getting the upside of the market without any downside. Ignorance can be blissful, if only momentarily.
Cons
Unfortunately for each of the pros, there are pretty significant cons. At this time, prevailing interest rates (and correspondingly the rates used to calculate immediate annuity payouts) are so low that committing funds could expose you to a meaningful amount of inflation risk. So even if you're predisposed to lock in a more secure income stream with an immediate annuity, consider waiting until rates normalize. The same could be said for most fixed annuities.
The tax deferral of annuities is worth something, but there's a price—or prices, really—to be paid. All of your gains will be taxed at your ordinary income rate. Especially if you're investing in a variable annuity with equity exposure, you're trading the tax privilege of capital gains for a rate—deferred or not—that could be twice as much.
Another negative tax implication is the loss of a "step-up" in cost basis to your heirs. Capital assets that were purchased at a low cost—like stocks and real estate, for example—are afforded a step-up in their cost basis upon your death.
If you sold those assets during life, you'd paid capital gains tax. If you gave them to your heirs while you were alive, your heirs would inherit your cost basis. But if you wait to pass them to heirs until after your death, they will receive a step-up in their basis to the cost of the holding on your date of death.
Annuities with significant appreciation, however, receive no such benefit. In fact, not only will your heirs inherit your cost basis, they'll be paying tax at their ordinary income rate and may be forced to distribute the policy and take that gain in short order, resulting in a tax time bomb for those you hope to bless with an inheritance.
There are more pros and cons - please visit my website or call me to discuss your particular situation.
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The cons of owning an annuity can be significant. Liquidity is a concern. In general the longer the hold position the higher the surrender charge. Fixed interest rates that lock down long positions like the present 3.25% for ten years could be too long if rates go up over the next decade. Today’s five year rate is 2.95%. Is the extra 35 basis points worth it for double the time period?
Immediate annuities are, in my opinion, the most useful of the suite. For Americans who will not be retiring with a meaningful stream of pension income, immediate annuities offer that potential. Because an immediate annuity is purposefully consuming both interest and principal to create an income stream, the individual distributions are likely to be higher than anyone could justify taking from a balanced portfolio of investments, where maintenance of the principal balance is often the goal.
Fixed annuities allow an investor to lock in rates of return that are comparable to CDs, but likely for longer terms (whereas CDs are typically quoted in months, fixed annuities are quoted in years ranging from one to 10.) The most common are three, five and seven year fixed annuities. If (read: when) interest rates rise from abnormally low rates to abnormally high rates, it could be a wise time to allocate some of one's fixed income exposure to a fixed annuity.
And unlike a CD—the interest from which is paid out and taxed annually—the interest or gains earned in annuities are deferred until distributions are taken.
Many annuities promise some level of principal protection. Even in certain variable products (invested in equities), a portion of your principal or even future income may be guaranteed by the company.
The advantages of equity indexed annuities are, frankly, hard to find amidst the overly-simplistic marketing pledges shrouding their overly-complex underlying construction. ... Whoever sells you the policy will likely be going on a nice vacation soon—commissions on these products range into double-digit percentages. Additionally, you could suspend disbelief and allow yourself to think you're getting the upside of the market without any downside. Ignorance can be blissful, if only momentarily.
Cons
Unfortunately for each of the pros, there are pretty significant cons. At this time, prevailing interest rates (and correspondingly the rates used to calculate immediate annuity payouts) are so low that committing funds could expose you to a meaningful amount of inflation risk. So even if you're predisposed to lock in a more secure income stream with an immediate annuity, consider waiting until rates normalize. The same could be said for most fixed annuities.
The tax deferral of annuities is worth something, but there's a price—or prices, really—to be paid. All of your gains will be taxed at your ordinary income rate. Especially if you're investing in a variable annuity with equity exposure, you're trading the tax privilege of capital gains for a rate—deferred or not—that could be twice as much.
Another negative tax implication is the loss of a "step-up" in cost basis to your heirs. Capital assets that were purchased at a low cost—like stocks and real estate, for example—are afforded a step-up in their cost basis upon your death.
If you sold those assets during life, you'd paid capital gains tax. If you gave them to your heirs while you were alive, your heirs would inherit your cost basis. But if you wait to pass them to heirs until after your death, they will receive a step-up in their basis to the cost of the holding on your date of death.
Annuities with significant appreciation, however, receive no such benefit. In fact, not only will your heirs inherit your cost basis, they'll be paying tax at their ordinary income rate and may be forced to distribute the policy and take that gain in short order, resulting in a tax time bomb for those you hope to bless with an inheritance.
There are more pros and cons - please visit my website or call me to discuss your particular situation.