Consider the pros and cons
An annuity can often be a great addition to your retirement portfolio. Here are some reasons to consider investing in an annuity:
• Your investment earnings are tax deferred as long as they remain in the annuity. You don’t pay income tax on those earnings until they are paid out to you.
• An annuity may be free from the claims of your creditors in some states.
• If you die with an annuity, the annuity’s death benefit will pass to your beneficiary without having to go through probate.
• Your annuity can be a reliable source of retirement income, and you have some freedom to decide how you’ll receive that income.
• You don’t have to meet income tests or other criteria to invest in an annuity.
• You’re not subject to an annual contribution limit, unlike IRAs and employer-sponsored plans. You can contribute as much or as little as you like in any given year.
• You’re not required to start taking distributions from an annuity at age 72 (the required minimum distribution age for IRAs and employer-sponsored plans). You can typically postpone payments until you need the income. [Due to the Coronavirus Aid, Relief, and Economic Security (CARES) Act, required minimum distributions (RMDs) are waived in 2020.]
But annuities aren’t for everyone. Here are some potential drawbacks:
• Contributions to nonqualified annuities are made with after-tax dollars and are not tax deductible.
• Once you’ve elected to annuitize payments, you usually can’t change them, but there are some exceptions.
• You can take your money from an annuity before you start receiving payments, but your annuity issuer may impose a surrender charge if you withdraw your money within a certain number of years (e.g., seven) after your original investment.
• You may have to pay other costs when you invest in an annuity (e.g., annual fees, investment management fees, insurance expenses).
• You may be subject to a 10% federal penalty tax (in addition to any regular income tax) if you withdraw earnings from an annuity before age 591⁄2, unless you meet one of the exceptions to this rule. [Due to the CARES Act, penalty-free withdrawals of up to $100,000 will be allowed from individual retirement annuities in 2020 for qualified individuals affected by COVID-19.]
• Investment gains are taxed at ordinary income tax rates, not at the lower capital gains rate.