Is a tax-deferred annuity a good investment for you?
I found this in the LA Times (warning: registration required):
If two insurance trade groups have their way, all investors will discuss that question with their insurance agents before buying.
The American Council of Life Insurers and the Insurance Marketplace Standards Assn. recently announced a push to extend “suitability” protections to every consumer. These protections require insurance salespeople to consider an investor’s time horizon, assets and goals before recommending an annuity.
A handful of states, including California, have instituted these protections, but only for investors age 65 and older. This is the first time that insurance agents would be required to discuss the issue of suitability with buyers under 65.
But there’s a catch: Neither insurance organization — nor the National Assn. of Insurance Commissioners, which has been pressing for laws on disclosure and annuity sales practices since 2003 — has any authority to make it happen. In the last three years, only 11 states have moved to protect seniors from abusive annuity sales. And just eight states require detailed disclosures of the pros and cons of an annuity.
Even though financial experts say that tax-deferred annuities are rarely a suitable investment for anyone, the products are gaining popularity. In 2004, the last year for which statistics are available, $224 billion in tax-deferred annuities were sold, more than twice the sales from 10 years earlier.
Tax-deferred annuities are designed to allow people to save money for retirement on a tax-deferred basis. Money put into an annuity is contributed with after-tax dollars, and the income it earns is tax free until the money is withdrawn.
The big drawback: the costs.
First, the annuity obtains its favored tax status by including an insurance element, which promises the buyer a death benefit guarantee. But that benefit comes at a cost: The typical annuity includes so-called mortality and expense charges, which can add up to 0.5% to 1.5% annually.
Another cost is the big tax bite. Although investment income isn’t taxed as it accumulates, all that income is taxable when it is withdrawn at retirement. Moreover, it’s taxed at ordinary income tax rates, which can be as high as 35%, not capital gains rates, which currently top out at 15%.
If money is taken out before age 59 1/2 , the withdrawal also can be subject to penalties.
The combination of mortality and expense charges and the higher tax rate make annuities a high-cost investment.