How to Buy Annuities

Annuities can prove to be a valuable element in funding your retirement plans. An annuity is basically a contract for which you make an up-front payment. In return, the company selling the annuity promises to pay you regular payments in the future. But you must know how annuities function and what their key features are.

Things You'll Need
Start shopping. Insurance companies, banks, brokerage houses, mutual-fund companies, and even nonprofit organizations all sell annuities.

Learn the two basic kinds of annuities and how they differ.

A fixed annuity guarantees you a certain future payment. This is a good option only for very, very conservative investors. The rate of return on your money is low, and annuities use actuarial tables based on a person living to be 100.

With a variable annuity, you choose where to invest your money, and the size of your payment depends on the performance of that invested capital. They are a great way to invest money tax-deferred that is not otherwise eligible for retirement savings. You can choose to invest in stocks, mutual funds, money markets and other options.

Put money into the annuity during the accumulation period; receive payments during the payout period. Choose between immediate or deferred payouts.

Check out the tax implications: You don't pay any tax on the annuity as long as you don't withdraw any money. Once the payout begins, the money you receive is taxed as ordinary income.

Be aware of penalties. If you begin to take money out prior to age 59 1/2, you may be hit with a 10 percent IRS penalty, on top of any taxes for which you may be liable. Additionally, the company may assess surrender charges if you take out money not long after you made a deposit (but that can sometimes be as long as 10 years).

Choose a beneficiary. Should you die before the payout period-- or at some point during the payout period itself--your beneficiary gets a death benefit (either all the money in the account or a predetermined minimum).

Be clear on what the other fees are, such as any mortality and expense risks charges and administrative fees. And always get a complete list of all fees and charges attached to any annuity.

Work with your tax adviser when considering an annuity. For all the tax advantages of annuities, you may do better in the long run with an IRA or a 401(k) plan where you work.

Tips & Warnings

If you're considering a variable annuity connected with a mutual fund, ask about the fund's performance, just as you would with any mutual fund.
Studies show that variable annuities only make sense for people with a longer time frame. Schwab estimates that it takes 5 to 15 years before the tax benefits outweigh the often-higher fees imposed by variable annuities.
Ask about a "free look" period to assess communication and record keeping. Many companies let you own an annuity for up to 10 days. Then, if you're dissatisfied in any way, it will return all your money without any surrender charges.
There can be inheritance tax disadvantages to annuities. The growth of an annuity can be fully taxable as income. Some other investments have a stepped-up cost basis.
Independent ratings on annuities are hard to come by. Get advice from your financial planner before choosing an annuity.