Before You Sign Up for an Annuity, Here's What You Should Know

You may have heard the insurance industry rejoice last week when the Obama administration's Middle Class Task Force released a report that, among other things, pushed annuities as a tool to help guarantee retirees a steady stream of income.

"This is a response to the fact that folks are living longer, and a guaranteed income is critically important to their well-being. We're planning to help organize that information and promote competitive products with consumer protection," explains Jared Bernstein, executive director of the White House Task Force on the Middle Class.If you're not familiar with the annuity, which is essentially an investment-insurance hybrid, here's the gist: You deposit a chunk of cash, then receive it back, either right away or at a set date in the future. You can get it in a lump sum, or in regular "paychecks." Annuities come in several types, and many have gotten a bad rap. Indeed, they can be confusing, not to mention expensive.

Bernstein acknowledges this. "These plans can be costly, complex, aggressively marketed in ways that are terribly nontransparent, and that's obviously why we need to do here what we think is so important in all areas in family financial dealings, which is effective consumer protection."

Basic Training

You can start with a little due diligence of your own. Before you jump on the annuity bandwagon, get to know some basics about the menu of options that are available:
  • A variable annuity invests your initial deposit, and the performance of those investments ultimately determines your payouts. If the market rises, you'll get more. If it dips, you get less. There is often a minimum return, set at the time of purchase, that acts as a guarantee, but you may pay more for this feature. Variable annuities, as a whole, tend to be expensive because of high fees.
  • A fixed annuity still invests your deposit, but always guarantees you a set return. Your payout will be based on how much you contribute, your age, and the interest rate at the time of purchase – not the moods of the market. If you have a lower risk tolerance, this is the annuity for you. Fees are generally built into your interest rate, so you may not know what you're paying unless you ask -- which, of course, you should.
  • A deferred annuity is a type of fixed or variable annuity. With this product, you put off your payouts for a set period, until you need them, so it's ideal for a long-term point of view. In the meantime, your money will grow tax-deferred. Deferred annuities typically have a death benefit, so the account beneficiary is guaranteed the principal and earnings. This kind of investment should be considered only after you've maxed out your 401(k) or IRA.
  • Finally, immediate annuities are the most consumer-friendly and easiest to understand. An immediate annuity returns your lump sum investment right away in regular chunks (often monthly). You decide upfront the length of time you want to receive the payments for -- five years, the remainder of your lifetime, even the rest of your spouse's life. The longer the time frame, the lower your payments. You pay taxes only on the part of your annuity payment considered earnings, not the principal. Immediate annuities can be fixed or variable. And again, be clear on the fees before you sign on the dotted line.
Jean Chatzky is an award winning journalist and best-selling author. Her most recent book is Money 911. Check out Jean's blog at and learn more about The Debt Diet Online.
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