How to Choose the Right Kind of Annuity

Purchasing an annuity is one of the most effective ways to save and invest tax-deferred earnings and have them paid back to you over time down the road. If you've decided that an annuity is suitable for you, here's a framework to help you narrow your search.

Difficulty: Moderate

Instructions

Things You'll Need:

• Wall Street Journal
• Financial Calculator
• Brokerage Accounts

1. Determine your tolerance for financial risk taking: Is it high, moderate or low?

2. Define your long-term investment objective: Is it aggressive, moderate or conservative?

3. Choose a fixed annuity if your risk tolerance is low, your investment objective is conservative, and you want the most guarantees available.

4. Choose an equity-indexed annuity if your risk tolerance and investment objectives are moderate and you'd like to peg account growth to market indexes.

5. Choose a variable annuity if your risk tolerance is high, your investment objective is moderate to aggressive, and you're willing to forgo some guarantees for higher, upside potential for account growth.

Tips & Warnings

• Annuities can be purchased from insurance agents, investment representatives at many banks, and brokers at securities firms.
• Rates of return of fixed annuities are comparable to those of many certificates of deposit (CDs), but unlike with CDs, growth is tax-deferred.
• There is no maximum contribution to annuities as long as they're held outside of a retirement account (IRA, 403(b) and so on).
• An annuity held in a retirement account provides a guaranteed death benefit.
• Variable annuities allow the owner to invest in both fixed accounts and mutual funds.
• Most annuities are "no-load" in that all of your deposits go to work for you right away.
• The net cost of investing in mutual funds inside an annuity is approximately 65 basis points, or 0.7 percent, more than the cost of investing in retail mutual funds.
• Avoid putting money that you may need within a few years in an annuity.
• Be aware that deferred sales charges (surrender fees) will be imposed if you cash out too soon.
• Avoid buying any annuity with mutual funds until you receive and read the prospectus.
• The cost of insuring an annuity is subtracted from your account value whether there are gains or not.
• Try to avoid adding extra-cost riders or benefits to your annuity that you're not likely to use, as they'll reduce the net growth of your account values.
• "Living benefits," if offered, require that you annuitize the contract to realize the benefit.
• Tax-deferred growth may cost you more than you actually save in taxes, so before you buy, take the time and effort to run the numbers.