How to Understand Fixed and Variable Annuities
Investments can be baffling, and annuities are no exception. Annuities are a life insurance product, but rather than paying out upon your death, an annuity begins to pay out when the owner of the annuity retires, although no earlier than at 59 1/2 years old. Payment can be taken in a lump sum or in monthly, quarterly or annual payments. If you are considering an annuity, you will need to understand the differences between variable- and fixed-rate annuities.
Other People Are Reading
Instructions
-
-
1
Know what a fixed-rate annuity is. Fixed-rate annuities earn a guaranteed fixed interest rate. Certificates of deposit (CDs) also earn and pay out a fixed rate, but fixed-rate annuities often earn a higher rate than CDs.
-
2
Know what a variable-rate annuity is. Variable-rate annuities pay out according to the performance of various investments in which you have your annuity money invested. You do not personally choose individual stocks and commodities. Rather, you choose a portfolio of investments from an array of portfolios that the insurance company offers.
-
-
3
Know the pros and cons of fixed-rate annuities. A fixed-rate annuity, because of its guaranteed interest rate, will give you a steady payout month after month, year after year. Your money is not subject to stock market fluctuations. Fixed-rate annuities are less costly to buy. You can invest with as little as $1,000. They are also tax-deferred. You are only taxed on the amount of interest that you pull out. According to CNN Money, fixed-rate annuities do have disadvantages. The initial rate may be guaranteed for a limited time, after which it will fall. Withdrawing your principal will result in heavy fees. Also, inflation can eat away at the value of fixed-rate annuities. Your principal may not grow fast enough to keep up with the cost of living. In addition, the fees that the insurance company charges can take a big bite out of your yield.
-
4
Know the pros and cons of variable-rate annuities. Variable-rate annuities are more likely to grow than fixed-rate annuities are. This will give you a hedge against inflation. Their earnings are also tax deferred until you withdraw them. On the other hand, as a more aggressive investment instrument, they also carry greater risk. If the value of your portfolio plunges, so will your payout. They also have heavier tax consequences than other investments might. As you withdraw earnings, the IRS treats them as regular income, rather than long-term capital gains. The tax rate on regular income is higher than the rate on capital gains. Additionally, the variable-rate annuity fees, which include sales commissions in addition to the management and ongoing insurance fees of fixed-rate annuities, are usually high.
-
5
Consult a certified financial planner to learn more before buying an annuity. Financial expert Terry Savage of MSN Money advises doing your homework. There is more to learn about annuities than differences between fixed- and variable-rate annuities. As well, there are more types of annuities than those two, so protect your money first by speaking to a trusted, well-recommended professional.
-
1
