Should Annuities Be Part of Your Retirement Plan? Part 1

Should an annuity be part of your retirement plan? In part one of a three-part series, managing partner and CERTIFIED FINANCIAL PLANNER™ Allen Stocker explains what annuities are, how the most basic “fixed” contract works, and the tax rules that make annuities behave very differently from other investments.

Video transcript

Hi, my name is Allen Stocker, certified financial planner and managing partner here at Patriot Asset Advisors. One of the topics we get quite often is: should I invest in an annuity, and what are they? So we’ve put together a three-part series covering the different types of annuities and how they function.

What is an annuity? An annuity is a contract between you and an insurance company, and they’re designed for retirement. The contracts come in a variety of forms. The fixed contract is the most basic — think of it like a CD with a bank, only you’re dealing with an insurance company. Basically, it gives you a money-market-type rate of return. These are retirement accounts, so there are a couple of things to be aware of: if you take the money out before age 59½, there’s a penalty, just like with an IRA.

With a fixed contract, the insurance company agrees to pay you a specific amount annually for a set period — whether that’s 3, 5, or 7 years. After that period, the company will determine your new rate of return, or you’ll have the opportunity to move the money to a different carrier. If you move the money before that time, there will be a surrender charge, which can be rather steep. Other contracts include the fixed index annuity, which is highly popular — we’ll cover those in video three — and the variable contract, which we’ll discuss in video two.

One other important topic is how annuities are taxed — they’re taxed quite differently from a lot of other investments. For you as an individual, any and all gains on the contract are taxed at ordinary income tax rates when you take the money out. That’s quite different from, say, a stock dividend, which is taxed at a lower rate. Annuities are also very unfriendly for estates. Think of it this way: if you put $100,000 into a stock and it grows to $300,000, your heirs receive those shares and the $200,000 of gain passes to them tax-free. If that $100,000 were in an annuity and grew to $300,000, your heirs would have $200,000 of income tax hit their account. So you’ll want to be aware of that before investing in an annuity contract.