By: Josh Slocum, McClellan Wealth Management
If I asked you what an annuity is, could you tell me?
If the answer is no, you’re not alone!
An annuity is essentially an insurance contract. For example, when you purchase an annuity, you pay a set amount of money today, or over time, in exchange for a lump-sum payment or stream of income in the future.
There are five major types of annuities— fixed, variable, fixed-indexed, immediate and deferred, and the amount of money you pay, and receive, depends on which type of annuity you choose.
Annuities can be confusing and are about as clear as mud— which is not always an accident on the part of those selling them.
When it comes to annuities, the pros and cons are not always balanced. An annuity can sound very enticing when pitched by a salesperson who, uncoincidentally, may be making a large commission selling them. Maybe they’re looking out for your best interest; maybe they’re not. Either way, annuities have their pros and cons when it comes to planning for your future.
The Disadvantages and Advantages of Annuities: Here are a few things you should know before committing to an annuity.
Early Withdrawal Can Mean Hefty Penalties
Withdrawing from your annuity before blowing the candles out on your 59 ½ birthday cake (if celebrating half birthdays is your thing!) could send big penalties your way. Taking distributions before reaching this age could potentially cost you 10% or more.
Seeing as annuities are not known as overly aggressive investment vehicles, the penalty for early withdrawal could potentially wipe out all of your gains and then some.
On the other hand, if you don’t withdraw early and keep your money invested, you may be able to put away a nice sum of cash for retirement.
High Commissions and Hidden Costs
If you have a life insurance agent, or if you’ve met with one, they may have heavily pushed annuities. Every wonder why? Well, the commissions that life insurance agents receive from annuities are often massive, but this money doesn’t just fall out of thin air.
The commission money that agents get from selling annuities comes from you— yeah, you! The hidden costs you pay after purchasing an annuity are, ultimately, in many cases, what’s writing those big commision checks for life insurance agents.
Now, this isn’t to say that everyone selling annuities is out to do you wrong. Sometimes, they are looking out for your best interest and truly believe this is the right option for you. Not all companies out there pay the typical high commission on annuities, and there are some agents who are transparent about the fees involved. You just have to watch out and make sure you’re working with the right agent.
Tax Disadvantages
You may have heard that you do not have to pay taxes on an annuity during its growth phase, which is true. This is a big advantage of annuities. But before you get too excited, you should be aware of the fact that once you begin taking distributions, not only are you taxed, but the rate is higher.
Annuity gains are taxed as ordinary income, not as long-term capital gains.
Developing a Financial Plan In Birmingham, Alabama
When it comes to your money and your future, you want to make sure that you’re doing what’s best for you, but with so many options it can get overwhelming. With the help of a financial advisor, you can create a comprehensive financial plan that will help you make the right decisions when it comes to investing and preparing for retirement.
At McClellan Wealth Management, we are committed to helping you create a financial plan that will make you feel financially secure and work to set you up for the stress-free retirement you deserve. Contact us today to discuss a plan for your financial future.
This material is provided as a courtesy and for educational purposes only and is not intended to be relied upon as specific investment advice and is not a recommendation, offer or solicitation to buy or sell any security. The opinions expressed here are those of the author and not Advisor Services Network, LLC.
An indexed annuity is for retirement or other long-term financial needs. It is intended for a person who has sufficient cash or other liquid assets for living expenses and other unexpected emergencies, such as medical expenses. Guarantees provided by annuities are subject to the financial strength of the issuing company and not guaranteed by any bank or the FDIC.
Indexed annuities do not directly participate in any stock or equity investment. Clients who purchase indexed annuities are not directly investing in the financial market. Market indices may not include dividends paid on the underlying stocks and therefore may not reflect the total return of the underlying stocks; neither a market index nor any indexed annuity is comparable to a direct investment in the financial markets.
Variable annuities are offered only by prospectus. Carefully consider the investment objectives, risks, charges and expenses of variable annuities before investing. This and other information is contained in each fund’s prospectus, which can be obtained from your investment professional and should be read carefully before investing. Guarantees are based upon the claims paying ability of the issuer.