by Barbara Parrott McGinity, LMSW
We all get the postcards offering us a free lunch or dinner to come and learn how to invest for retirement. And in today’s environment where 401K plans and investment accounts have taken a hit, many folks who are already retired are worried their money will not last. Often times, the individuals offering the free food are insurance agents selling annuities. It is important to remember that free food comes with a hard sell, and more often than not, it is an investment product such as an annuity which may not be the best product for an older adult.
An annuity is a type of financial insurance contract that can accumulate value and provide a steady stream of income over a long period of time. For this reason, annuities are typically used to build retirement savings, although they can also be a tool to save for a child’s education, create a trust fund, or provide for a surviving spouse or heirs. Because annuity earnings may grow tax-deferred, people who are primarily concerned with limiting their taxes also frequently purchase them.
Annuities are not right for everyone. They typically take several years to become profitable. Therefore, they are not a good financial option for people with a short-term financial goal. If you’re considering purchasing an annuity, it’s a good idea to consult an accountant, attorney, or trusted financial adviser.
The following scenarios illustrate when an annuity might be – and might not be – a good investment:
• If you are already retired, an annuity is probably not a good option because it can take many years for the contract to become profitable. Annuities are generally best used to provide for retirement when purchased at least five to10 years before you retire.
• If you do not have any other investments or savings accounts, an annuity is probably not a good place to start. It is generally a good idea for investors to have at least some investments that can be quickly converted to cash in case of an emergency or sudden need. You may have to pay a substantial surrender charge – which can be as high as 25 percent – if you withdraw your money within a certain number of years of purchasing an annuity.
• If your financial goal is to generate a guaranteed income stream for retirement, certain types of annuities that make fixed monthly payments for the remainder of your lifetime can be a good option.
• If you have the financial discipline to accumulate and maintain your contract for the long term, an annuity can be a good option. Cashing in an annuity in the short term can result in significant surrender charges and could increase your tax obligations.
• If you’re currently in a high-income tax bracket, but expect to be in a lower tax bracket in the future, such as in retirement, an annuity can be a good choice because earnings are tax-deferred. This means an annuity’s earnings aren’t taxed while they grow, only when you actually make a withdrawal or receive a payment from the contract. If you contribute to an annuity while you’re in a high tax bracket and receive payments while you’re in a lower one, you will probably pay less in taxes than you would with other types of financial options.
• It is also important for you to consider your other debts, i.e., student loans, home equity loans, before purchasing an annuity.