At first blush, annuities sound like a good deal for investors who would like to set aside capital and obtain defined, periodic payments over the long term. However, annuities, and more specifically variable annuities, can be difficult to understand. They can turn out to be more costly than originally expected, and due to their tax-deferred nature, they are typically inappropriate for retirees.
For the average investor, the length of the typical variable annuity prospectus can be intimidating enough. Some are longer than 100 pages. Then, the often-lengthy document’s forbidding quality is amplified by the use of cumbersome legal language that clearly was not intended for the layman. Add to that backdrop the fact that a series of confusing surrender charges and fees are woven into the prospectus. The combination makes for a very complex document indeed.
The basic premise of the variable annuity is that it acts as an insurance contract guaranteeing a minimum payment. But the remaining portion of the payment is tied to returns on stock indices such as the S&P 500 (which, therefore, makes the annuity variable). In addition, annual fees, commissions and high surrender fees for early withdrawals can erode the overall performance of an annuity.
Because the commission for selling a variable annuity often amounts to a juicy 10 percent, brokers find it difficult to resist pitching them to older investors. However, a variable annuity usually does not make sense for retirees, who rarely benefit from a tax-deferred investment. Often, retirees have already moved to a lower tax bracket than the one they were in when they were working.
Any would-be investor should enlist the advice of an experienced estate-planning attorney to help determine whether annuities would make sound investments for his or her plans and, if so, what portion of an overall portfolio should be invested in them.
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