Both annuities and life insurance can be used as investment vehicles with tax-deferred growth
, but it’s important to understand the pros and cons before putting your money into them.
An annuity is a contract with an insurer in which you agree to pay the company a certain amount, either in a lump sum or through installments. In turn, it makes a series of payments to you starting now or at some future date. Those payments can be scheduled to last for a specific period of time, like 15 years, or for a lifetime. Lifetime annuities have the obvious attraction of lessening anxiety over outliving your assets.
The dollar amount of your payments will depend on the value of your underlying account. You can choose between fixed annuities with a guaranteed rate of return or variable annuities, whose returns rely on the performance of your selection of stock and bond funds. An indexed annuity is similar to a variable annuity, but its earnings are tied to a specific benchmark, like the S&P 500.
With all types of annuities, high upfront commission fees can cut deeply into your long-term earnings. There are also strict rules for the timing and amount of distributions. If you need any of your money early, you may lose 5-7% of your withdrawal as a penalty.
In an annuity, your earnings grow on a tax-deferred basis and this can be a benefit. nce you start withdrawing funds, any gains are taxed at regular income tax rates. This is in contrast to stocks and bonds, in which your earnings are taxed at the lower capital gains rate.
Whole and variable life insurance provide a tax-free death benefit — the money you pay into the policy may be distributed to your beneficiaries upon your death, tax-free.
Also, if managed correctly, whole life policies can provide you with tax-free loans. Loans can be used for a variety of reasons, including supplemental retirement income. Loans come directly out of the death benefit that would go to your beneficiaries and do not need to be paid back. Interest payments, although required, can be taken out of the cash value also. However, if you ever surrender your policy or let it lapse, you’ll have to pay the interest and report the taxable part of the loan (the amount of the loan minus total premiums paid) as income. You will then need to pay taxes on it at a regular income tax rate.
Both of these vehicles can come with high fees and complicated tax consequences, lessening their efficiency as savings and investment vehicles. Consider fully funding tax-advantaged vehicles like 401(k)s and IRAs first.
It’s best to consult with a financial advisor about how annuities or insurance might fit into your total investment strategy. A United Capital advisor has the expertise and dedication to help you structure your financial picture to provide you with the kind of life you truly want to live.
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