Pros And Cons Of Annuities (Fixed Index And Variable Annuities), talk if an annuity is a series of payments that are made at equal intervals. Some examples of annuities are regular deposits to a savings account, monthly home mortgage payments, monthly insurance payments and also pension payments. Annuities can be classified based on the frequency of payment dates. The payments (deposits) may be made on a weekly, monthly, quarterly, yearly, or at any other regular interval of time. For this article, we look at the pros and cons of both the fixed index and variable annuity types. Before we discuss the Pros And Cons Of Fixed-Index Annuities and variables annuities, let’s define what both of them are.
PROS AND CONS OF ANNUITIES – FIXED INDEX AND VARIABLE ANNUITIES
These are annuities that have fixed payments. If it is provided by an insurance company, the company guarantees a fixed return on the initial investment made. Note that fixed annuities are not regulated by the Securities and Exchange Commission.
These are products that are registered and regulated by the SEC. They allow for direct investment into various funds that are specially created for Variable annuities. Typically, the insurance company involved guarantees a certain death benefit or lifetime withdrawal benefits. so, in this write up we will be discussing the Pros And Cons Of Fixed-Index Annuities and variables annuities in the subsequent section.
Pros And Cons Of Fixed-Index Annuities
A fixed index annuity, or an FIA, is a financial product that is sold by an insurance agency. It allows the interest to accumulate on a deposited amount in a tax-favored account while it is often designed to provide a distributed income payment. It is a very easy way to create income for oneself in a manner that is similar to a pension, but instead using one’s own saved money to do so. The main advantage of a fixed index annuity is that the earnings it is able to create grow based on a tax-deferred basis. No income taxes will be paid on the money until it is withdrawn from the annuity. Some people may be able to purchase their FIA using rollover funds from a tax-qualified plan or from a lump-sum distribution from another retirement option without being subjected to severe tax implications. The primary disadvantage of a fixed index annuity is that the cost of the initial investment is usually high. Many carriers of this type of annuity have a minimum investment amount of $100,000 that is required to create the initial account. Ongoing premiums may also be part of the contract. For those who are interested in using the FIA for future income, the average monthly payment received from a $100,000 investment would be about $500. To $1,000 per month, up to $250,000 investment may be required. The pros and cons of fixed index annuity are discussed in full below. This will help you to weigh up your options before making the investment.
Pros Of Fixed Index Annuity
- Fixed index annuities offer guarantees. A fixed index annuity offers such high levels of financial safety when it is compared to other investment products. The earnings and also the premium are contractually guaranteed by the issuing insurance company.
- Most FIAs allow for multiple deposits over time. The average fixed index annuity is usually set up to be able to receive flexible premiums. This type of annuity allows for multiple deposits to be made into the account over time. There are single-premium FIAs on the market too that would only accept a one-time initial premium. It is therefore important that you carefully read the contract of the annuity before agreeing to its structure to ensure you receive the right level of flexibility.
- Most FIAs allow for a right to examine. In the U.S., most states require the insurance carriers to provide new investors with a provision that is called a “right to examine.” Think of this as a free trial period for the annuity. If you don’t like what you see after initially agreeing to the terms and conditions of the annuity, the right to examine allows for a full refund of the initial investment for any reason.
- The average fixed index annuity earns a much higher interest rate than similar banking products.
- It is a great way to save for retirement when all other options have been maxed out.
- Many FIAs permit an early retirement without imposing a penalty.
- Money isn’t lost on a down market.
- An FIA creates a diversification option. Even for an investor who is a strong believer in the markets, a fixed index annuity provides another layer of diversification that can protect an income. Although taking some amount of money and locking it away for up to 10 years before touching it again may not be the best option for everyone, an annuity with a guaranteed income rider could create some comfort during the years of retirement. Some riders even allow for lifetime income of certain levels, even if the all of the initial investment has already been withdrawn.
Cons Of Fixed Index Annuity
- Most fixed index annuities will lock up your cash for extended periods of time. Some available FIAs on the market have a surrender period that may be up to 15 years. Even very good FIAs will lock up the initial investment for at least 5-7 years. You can however always withdraw your money before then, but then there will be a market adjustment to the final balance and a likely an early withdrawal fee that must be paid to the insurance company. If there are profits made from the annuity, the taxes would also need to be paid on them as well.
- Many FIAs may end up paying a lower overall interest rate. When compared to other available investment options, fixed index annuities often pay a much lower interest rate to the investor. In return, however, there is less risk and less volatility, but there is also a lesser risk of real wealth growth. That makes an FIA a very good option for those wanting to avoid risk almost entirely, but not a good option at all for those who are looking to build wealth through their investment portfolio.
- Most fixed index annuities also have caps on market performance.
- Surrender charges can be massive. Most available FIAs allow for about 10% of the principal of the annuity to be withdrawn without a surrender charge while anything larger than that will initiates this fee. On a 10-year FIA for example, the first four years of the policy may have a 10% surrender charge in place. Unlike in the case of a CD that removes the interest earned with an early withdrawal, an early withdrawal on an FIA would only result in a 10% reduction of the investment and a loss of the interest. For a $200,000 FIA, that is more than $20,000 in a penalty.
- Most FIAs do not provide inflation protection as inflation can destroy the potential of a fixed index annuity.
- Most of the income riders do not increase immediately the distribution phase begins.
This concludes the aspect of the pros and cons of Fixed index annuity which is an extract topic from the Pros And Cons Of Fixed-Index Annuities and variables annuities. Let’s now discuss the pros and cons of the Variable Annuity.
Pros And Cons Of Variable Annuities
The explosion of products and also services that have become available in the financial market as of today are enough to bewilder even the expert. But then there are very few vehicles that have succeeded in generating as much controversy in both public and professional forums as variable annuities. Many brokers and also planners view these unique vehicles as indispensable retirement planning tools, while other financial experts warn consumers to totally avoid them. Of course, there is no perfect answer to this issue, but consumers need to be aware and also understand the advantages and disadvantages of these investment vehicles before making a decision.
One of the problems that face many consumers when it comes to variable annuities is the difficulty in understanding how they actually work. Variable annuities probably only rank second to variable life insurance in terms of complexity. They bear semblance to their fixed and indexed cousins in that they are issued as contracts that grow on a tax-deferred basis regardless of whether they are placed inside an individual retirement account (IRA) or any other tax-deferred retirement plan. There is also a 10% early withdrawal penalty for distributions that are taken out before the contract owner is 59½, with certain exceptions for death, disability or other factors. But then variable contracts are unique in such a way that they offer a pre-selected group of mutual fund subaccounts into which the investor will then allocate the premiums paid. The values of the funds rise and fall with the markets with no guarantee on the principal. Most variable products are known to contain living and death benefit riders that guarantee either a minimum account value or a stream of income. But even this information is clearly not enough to allow consumers to make truly informed buying decisions. There is also a need to educate them on the pros and cons of variable annuities.
Pros Of Variable Annuities
Variable annuities can offer an investor a package of benefits that are usually unmatched by any other type of financial product on the market today. The main selling points of variable annuities include:
- Unlimited contributions: As mentioned earlier, there is no limit whatsoever to the amount of money that one can place in a variable annuity. It is for this reason they are quite popular with wealthy investors who are looking for tax shelters.
- Tax deferral: Like all other forms of annuities, variable annuities also grow on a tax-deferred basis. Only the distributions are taxed once they are made.
- Insurance protection: Most variable contracts available today offer an array of living and also death benefit riders that promise a guaranteed stream of income or else a minimum account value.
- The potential for superior returns: Investors who hold variable annuities for long-term can reap the associated growth in the fund subaccounts over time.
- Avoidance of probate: As with fixed and indexed annuities, variable annuity contracts also are unconditionally exempt from probate so that beneficiaries of these annuities can get their money quickly.
- Initial bonuses and high guaranteed rates: Many variable annuity contracts will pay the investor an instant bonus on money that is paid into the contract, or they may offer a dollar-cost averaging program that will pay a high fixed rate on the initial balance, and then move the money into the subaccounts that the owner chooses over a set period of time, such as six or 12 months.
Cons Of Variable Annuities
Despite their versatility, variable annuities are not all things to all people as they also have some real limitations. Some of the cons of variable annuities are discussed below.
- Poor cost basis: Unlike stocks or other types of securities, the cost basis of variable annuities does not step up when they are inherited. Beneficiaries will still pay tax on the entire contract value that has grown from the initial date of purchase.
- Poor tax treatment: Although these variable contracts grow tax-deferred until retirement, they also impose the same 10% early withdrawal penalty as with traditional IRAs and qualified plans.
- High fees: Variable annuities are some of the most expensive financial products available in the marketplace as of today. They come with a lot of fees and charges, including mortality and expense fees, mutual fund subaccount management fees, contract maintenance fees as well as other miscellaneous costs.
- Complexity: As it was previously mentioned, variable annuities are one of the most complicated financial instruments available today, and often they are poorly marketed and understood by both salespersons and consumers.
That is all you need to know about the Pros And Cons Of Variable Annuities and Fixed Index Annuities
Conclusion On Pros And Cons Of Annuities- Fixed Index And Variable Annuities
This article has shed light on the Pros And Cons Of Fixed-Index Annuities and variables annuities, in particular, the pros and cons of fixed index and variable annuities. This will help potential investors make informed decisions on these. so, with the Pros And Cons Of Fixed-Index Annuities and variables annuities, full details are written here, you can now boldly take any decision you wished to take.
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