Could someone please explain to me exactly what an annuity is? I understand CD's but someone suggested one time that I get an annuity and I'm not quite sure of the difference in the two TIA
Without getting too technical (because there are A LOT of different types of annuities) a CD is money invested at any point in your life with the interest. Annuities are TYPICALLY a retirement vehicle. You can get fixed or variable annuities. Basically, you put a sum of money into an annuity (and they are usually high minimums, at least 10k vs as low as $500 for a CD) and the money gains interest based on whether it's fixed or variable. You can choose the term. You can also choose whether to annuitize the contract, meaning that x amount of dollars will be paid to you on a monthly, quarterly, semi-annually or annual basis, depending on the contract you go into. Many life insurance companies offer annuities while banks can offer CDs. Because the annuity is not FDIC insured, banks cannot offer it as a bank product. They offer it instead as an investment vehicle. It is backed by the insurance company who is required by law to have the money and then some set aside. You can tend to look at a fixed annuity in very similar terms to a CD to help gain an understanding of it. Many people will never annuitize a contract because they are using the benefits to pass on to their heirs. There is SO much more that goes into it, but that is the basics of it.
It's complicated. Perhaps the most important difference is the tax treatment. CD's are short term investments that are taxed year-by-year on the interest. Annuities are retirement investments that are only taxed when money is withdrawn, but there are substantial penalties if the money is withdrawn (and not rolled over) before retirement. Annuities are good because they generally have higher interest rates and have bells and whistles. However, they are only good for retirement savings. If you are young, most folks (not me, but that's a different conversation) will tell you to put your retirement savings into variable products, not fixed-income annuities. But once you are at retirement, annuities really start to look good vs CD's. BIAS NOTE: Much of my employment comes from companies that sell annuities.
Lets clear the air on this....I market annuitites as a registered rep. CD's are good safe investments where you need fairly quick access to cash. The rates are not usually locked in for extended periods. Most common are 6 mth - 1 yr - 2yr and 5 yr. Rates are usually lower than annuities. The biggest draw back are those pesky 1099 interest forms that you have to report and pay tax on each year. So if you are earning 4% on your CD your effective yield after tax is 2.64% in a 33% tax bracket. This lowers the compounding of interest when using a CD as an investment. Annuities earn interest tax deferred and gain from the compounding of interest over time. Since most people are using this as a retirement account , they will most likely be at a lower tax rate upon retirement. Annuities offer interest payouts as soon as 30 days from date of deposit. Most allow 10% penalty free withdrawl each year. They can be funded with as little as $50.00 monthly with IRA guidelines and benefits of taxation. The best advice I can give you is that all insurance agents can sell annuities. Be selective in your choice of an agent that really knows your personal goals when placing you with a product. These offer very high commisions to agents. Ask questions about what are the penalties and how long are they in effect. (they usually start around 8% and drop each year) Ask about the minimum guarranteed interest rate. Ask about penalty free withdrawls for nursing home or some have for loss of employment. Beware of indexed annuities - look for very high penalties - I have seen some charging upto 20%. Interest rates on current fixed annuities start at around 7.9% 1st yr and 3.9% through 10 years. Some have rates fixed around 4.35 - 4.75% for 10 yrs. Recent rate history has shown annuities usually average about 1.0 - 2.5 points higher than average CD rates over a 10 year span.
There are dozens of different annuity designs - but all allow you to keep your money in as long as you want. The most common designs look somewhat like CD's. You will get a rate guaranteed for a period of time. Usually, the longer the time, the higher the rate. But you will pay penalties if you take out the money during that period.
You've been given some great info. The one question I didn't see anyone ask is if the money you would be investing is IRA or taxable? If taxable - then in a CD you would be getting taxable interest-thus the 1099. If it is an IRA then the interest would be tax deferred. Watch for the costs on a Variable annuity. There are no load (sales charge) annuities and some that have high expenses( because they have lots of guarantees that you pay for or that pays the rep) CNN Money gives some great info on annuities. I am also a reg rep and while I believe annuities can be great for income or wealth management there is a lot to evaluate before locking into one- they can be expensive to leave!
As the other posters said, the cds and annuitys have drawbacks such as taxable and not fdic insured. If you just want to invest and not lose your prinicipal maybe you might want to consider tax free municipal bonds. The principal stays in place and you get a nice monthly check, non taxable of course. It works for us.
OK I thought I understood this but now I am getting confused again. You mean the money you put into annuites could possibly be lost? Is that what you mean by it not being FDIC insured? Also please tell me more about these tax free municipal bonds. Which one of the three would be best to invest $8000 dollars in? Thanks again
Ariel, If the $8000 represents the bulk of your liquid assets I would place the money in either a CD if you can tie it up, or a Money Market account. If you will have a need to get to this money quickly an annuity is NOT the right product for you. An annuity is best suited for LONG TERM fixed investments or lifetime income streams. BONDS....a tricky investment at best....some are good...some not so good - I would use extreme caution with these. Loads- Difficult to sell- Defaults-
