Annuities
are similar to traditional Individual
Retirement Accounts and employer-sponsored 401(k) plans in that your
money can grow tax-deferred until you withdraw it from your
account. However, annuities are complex products and are not appropriate
for everyone near or in retirement. Here's an overview, including things
to consider and questions to ask before you invest.
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Annuities can be
purchased directly from an
insurance company or from other financial institutions (including banks)
that act on behalf of the insurance company. In exchange for your
investment, the insurer agrees to make periodic payments for a set time
period. It's important to remember that some annuities may lose value.
These products are not insured by the FDIC or the FDIC-insured bank or
savings institution that may offer them.
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There are different
types of annuities.
A "fixed annuity" provides a
fixed payment, often monthly, until the investor dies. It typically
guarantees no loss of principal (the amount invested). A "variable
annuity" also guarantees payment for a set period, but the payment
amounts will fluctuate based on the market performance of the investment
option you choose. With a variable annuity, you also risk losing
principal as well as earnings, although some variable annuities
guarantee the return of your initial investment for an additional fee.
If the income payments are deferred to some later date, the annuity is
typically described as a "deferred annuity." If the payments
begin immediately and continue for life, the annuity may be referred to
as an "immediate life annuity."
On the plus side, annuities provide another investment option if
you've reached your contribution limit on your other retirement
accounts, such as 401(k) plans. And, at retirement, the guaranteed
payments can provide extra income. But, as with any investment, be aware
of the potential pitfalls and make an informed decision.
Know the key features and costs of the product and make sure they fit
your needs. Read the literature to understand the most important facts
and risks, including the potential for loss, if any.
"A sales representative who talks to you about purchasing an annuity is
required by federal law to ask you questions about your investment
goals, current finances and future retirement plans," said Kara Ritchie,
an FDIC Policy Analyst who specializes in consumer issues. "If the
representative doesn't discuss whether the product is suitable for your
needs and goals, take your business elsewhere."
Experts generally say that annuities with guaranteed principal and
income are more suitable for older investors than annuities that may,
through market performance, lose value. The latter include
variable-rate, deferred-payment annuities and equity-indexed annuities
(those tied to the stock market), which might not make sense for many
investors close to or in retirement.
Also, before you sign a contract, make sure you understand the cost of
getting your money back early. Many investors with variable annuities
are surprised to learn that they must pay hefty "surrender charges" if
they try to withdraw money early, cancel their contract, or replace an
existing annuity with a new one.
Deal only with a competent, reputable sales representative. Most annuity
sales representatives are trained professionals. However, there have
been reports of sales representatives who have been poorly informed or
have used false or misleading tactics to sell annuities. How can you
improve your chances of getting good advice?
Work with a sales representative licensed by your state government's
insurance regulator (listed in your local phone book or on the Web site
of the National Association of Insurance Commissioners at
www.naic.org/state_web_map.htm ). If the sales representative offers
variable annuities, he or she also must be licensed to sell securities.
For information on whether a sales representative is properly licensed
or has a history of disciplinary problems, contact your state securities
regulator (in your phone book or from the North American Securities
Administrators Association at
www.nasaa.org/QuickLinks/ContactYourRegulator.cfm ) and the National
Association of Securities Dealers, a self-regulatory group for the
securities industry (1-800-289-9999 or
www.nasd.com ).
"Annuities are generally sold on a commission basis, so it's important
to find a sales representative who puts your interests ahead of his or
her own," added Ritchie.
Proceed carefully before replacing an existing annuity with a new one. A
sales representative may suggest investing in a new annuity paying a
higher return or replacing a deferred annuity with an immediate life
annuity to provide monthly income now instead of later. These actions
may make sense for some people. However, it can be expensive to change
annuities. Make sure you consider the contract terms as well as early
withdrawal penalties and other charges prior to making a change.
What if, soon after purchasing an annuity, you have "buyer's remorse" or
find another annuity with better terms? Your annuity may have a "free
look" period during which you can cancel without penalty. If yours
doesn't and you still want to cancel, determine all the surrender
charges and penalties and proceed with caution.
For more information about annuities in general, start with your state's
insurance regulator. For more information about variable annuities,
visit the U.S. Securities and Exchange Commission's Web site at
www.sec.gov/investor.shtml or call toll-free 1-800-732-0330.
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