Tax Deferred Annuity Financial Information
Annuities are insurance products designed to help you save money and provide a guaranteed income during retirement. When the annuity makes payments to you immediately, it is an immediate annuity. When the annuity defers this payment, it's called a deferred annuity or tax deferred annuity. Make sure you understand how these annuities work prior to investing in them.
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Types
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There are two types of tax deferred annuities. The first type is a fixed annuity. These annuities earn a fixed rate of return. A variable annuity is the second type of tax deferred annuity. A variable annuity does not earn consistent rates of return. Instead, interest varies according to investments embedded in the annuity contract.
Function
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Fixed annuities function by investing in bonds or bond-like investments. These investments pay a consistent, fixed, rate of return. Variable annuities function by investing in mutual funds. Mutual funds are a collection of stocks, or sometimes a collection of bonds, that share a common investment objective. The returns of the mutual fund are not fixed. Because of this, the variable annuity's account balance fluctuates according to the value of the funds you invest in.
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Benefits
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The benefit of a tax deferred annuity is that you avoid paying current income taxes on your savings. Another benefit of tax deferred annuities is that these annuities may be converted to immediate annuities during your life. An immediate annuity guarantees you a payment for your entire life or for a set period of time. Alternatively, you may keep your deferred annuity and simply withdraw money from it as needed.
Disadvantages
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The disadvantage to a tax deferred annuity is that the annuity is a long-term contract meant to be held until you reach age 59 1/2. If you need your savings prior to this age, you may pay an IRS penalty for early withdrawals from your annuity policy. This is in addition to any penalties imposed by the insurance company. Insurers set maturity dates on their tax deferred annuities. Maturities represent the number of years you must keep the contract before you may withdraw money or cash in the annuity without a penalty. In this way, annuities are somewhat illiquid investments.
Considerations
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If you want easier access to your money, or a more liquid investment, consider investing in investments outside of an annuity. Money markets, bank CDs and bonds all offer returns similar to fixed annuities. However, you'll be taxed on all of the gains you make every year. Mutual funds and stocks may offer you returns similar to a variable annuity.
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