Pros & Cons of Buying Annuities
Annuity retirement accounts provide a way for individuals to earn money on their initial savings investment rather than reaping minimal earnings from a traditional savings account. The different types of annuities available present their own sets of pros and cons; though individual planning needs can dictate which type will work best.
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Identification
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According to the Investment FAQ reference website, annuity products come in two varieties: fixed and variable. Fixed annuities provide a guaranteed, fixed source of retirement income, whereas variable annuities fluctuate according to market conditions. Investors can also opt for an immediate annuity that pays out as soon as the account is opened or defer payments until a later date. From a security standpoint, fixed annuities offer a reliable income source that's guaranteed to last for the life of the account holder. Variable annuities can potentially earn more money than fixed types, though there's also the risk of losing money should market conditions decline.
Function
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Annuities provide a means for an investor to earn money on a tax-deferred basis. They also provide a method for converting a lump sum of money into a steady stream of income, according to Investment FAQ. In the case of fixed annuities, there's the added benefit of principal protection, which means there's a guaranteed return of the principal investment amount. According to New Retirement, a retirement planning resource website, fixed annuities are backed by low-risk security investments so earned interest amounts remain low throughout the life of the account. And while fixed annuities provide the safest option, investors miss out on any possible market gains.
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Accessibility
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Accessibility in terms of being able to withdraw money without penalties attached is something to consider when buying an annuity. According to Investment FAQ, once a sum of money is placed in an annuity account, it can serve only one purpose, be it for immediate distribution or deferred. In some cases, contract terms will allow for withdrawals in the case of financial hardships. Should a person opt to surrender the account or cash out, certain contract terms may impose surrender charges if an account is closed prior to a certain time period of five or more years after the account start date.
Effects
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The potential for increased earnings with variable annuities results from the more risky investment vehicles that back variable accounts, according to Investment FAQ. The potential for increased earnings on investment is equally matched by fluctuating economic variables that can drain the principal balance of an annuity investment. What this means is investors can end up with less money than what they initially put into the account. As a result, actual distribution payments can fluctuate as well.
Considerations
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The tax protection provided by an annuity investment makes it a viable option in cases where someone wants to move monies from a 401k or IRA account. Since annuities are considered tax-qualified savings accounts, no tax penalties apply when moving monies from other types of investment accounts, according to New Retirement. Investors also have the option of protecting annuity earnings from the effects of inflation by purchasing additional inflation protection. And while inflation protection coverage will help maintain earnings levels, the cost of the coverage can take a significant chunk out of the initial lump sum investment or result in lower distribution payments.
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