Avoiding Annuity Errors

Everyone knows that when you buy a car you have to kick the tires and take a look under the hood. The last thing you want to do with your hard earned cash is lock it up in a lemon. Even after you make your decision, you have to keep up with the maintenance to get the most out of your wheels before trading it in for a newer model.

The same is true with your investments. You need to take the time to do the necessary research assessing your own needs and seeing what products best match your current situation and your goals for the future.

Take annuities, for example. Tax-deferred annuities are one of the best ways to put money away for retirement. Like your 401[k] or IRA, they offer the power of tax-deferral which means your money has the potential to grow much faster sometimes 30-40% faster than in similar taxable investments or equity funds. Even better and unlike your other retirement accounts annuities have virtually no limits on the amount of money you can invest. They are a great place to stash all or part of an unexpected lump sum, like an insurance settlement or bonus from the boss.

There are two popular types of annuities: fixed rate ones, which guarantee a rate of return, and variable annuities tied to equity market conditions with sub-accounts managed by asset management firms such as INVESCO, Janus, Oppenheimer, T. Rowe Price and Rydex. Naturally, variable annuities, as with any investment fund tied to the equity market, are sold through prospectus only and have risk, including the possible loss of principal.

And because annuities are traditionally sold by insurance agents and brokers who are paid on commission, extra care must be taken when considering annuities. The emergence of the no-load mutual fund and the online broker have revolutionized the mutual fund and brokerage industry respectively. A similar revolution is now underway in the annuity industry an emerging "new breed" of annuities have no-load and no surrender charges, and are available via the Internet. To help consumers with their investment decisions, below are some of the most common mistakes made when considering annuities.

1. Sheltering the "Wrong" Money from Taxes

   The money in your IRA, 401[k] and 403b grows tax-deferred wherever it's invested, so it doesn't need to be invested in an annuity. So, fully fund your IRA, Roth IRA, 403b or 401[k] first, then consider an annuity to tax defer additional funds.

2. Investing in An Annuity to Fund a College Education

   Any money taken out of the annuity prior to age 59½ will be subject to an IRS penalty of 10% plus ordinary income tax on the gain.

3. Trusting an Insurance Agent Too Much

   Remember, the insurance agent or broker will be paid a commission from the insurance carrier you invest with. The longer the surrender charge period and the higher the annual fees, the higher the commission that's paid.

4. Annuity In the Drawer

   Too many people buy an annuity, stick it in a drawer, and then forget about it. Annuities are assets and just like any other asset, they need to be managed.

5. Old Annuity Sitting Liquid

   One of the biggest mistakes you can make is to ignore your existing annuity once the surrender charges have expired--upgrade or exchange it for a new, more competitive annuity.

6. Buying an Annuity Primarily for the Bonus

   For variable annuities, a 3% to 5% bonus is sometimes offered to "help make up" for the surrender charges on an existing annuity. But beware most of these plans have a full nine years of surrender charges, a hefty Mortality & Expense Fee, and a large annual fee, all on top of the management fee. Similarly some fixed rate annuities offer the investor a great first year rate but then they lower the renewal rate to 4% or 5%, and you're stuck with a seven-year surrender period while the insurance company earns the bonus back.

7. Leaving Funds in the Money Market Account, Forever

   An astonishing number of investors do the research, pick a variable annuity, invest the money and then for some unknown reason, keep their funds in the money market sub-account, as if they're frozen.

8. Buying a "Trust Me" Fixed Annuity

   "Trust Me" annuities guarantee a higher interest rate for the first year and then ask the buyer to "trust" the insurance company that the rate will remain competitive after that (but their definition of "competitive" isn't always what you might expect).

9. Not Understanding Annuities are Long-Term Saving Vehicles

   Annuities are designed as long-term retirement savings vehicles. Earnings withdrawn prior to age 59 ½ may be subject to a 10% federal tax penalty. Individuals should consult their tax advisor for questions regarding their particular situation.

10. The Roach Motel Fixed Annuities

You can get in, but you can't get out. When buying any fixed annuity, simply ask if the rate guarantee period (the number of years for which the rate is guaranteed) matches the surrender period.

If there's one lesson to gain from the above, it's the need to do the research before putting your cash in any retirement fund. Talk to an investment advisor or do the research on the Internet. It's all about taking charge-only you can be the best possible expert in your financial future.

Tina K. Baughman, president and co-founder of AnnuityScout.com, is a registered investment advisor and a principal of Sentra Securities Corporation, a registered broker-dealer (member of NASD/SIPC). She is available to answer questions at 1-800 TAX CUTS.

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