An annuity is a tax-sheltered retirement vehicle. Choosing an annuity is a little intimidating. With so many types and companies that offer them, it's tough to make the right selection. Decide on the type of annuity you want before you choose a provider. Once you know what kind of annuity works best for you, it helps narrow down who you'll buy from and what the best deal is for your situation.
Select from fixed, variable or indexed. The fixed annuity works like a CD that rolls over continuously with a tax shelter. Your principal doesn't go up and down, but remains fixed and the insurance company adds interest. You might have a guaranteed interest rate initially, but once the period of guarantee ends, the company sets a new rate, frequently lower than the guarantee. Variable annuities have mutual funds as the method of investment. You choose how you want to divide your investments among the funds. The indexed annuity is a cross between the two. It uses an index, such as the S&P 500, and you participate in a percentage of the growth or receive a guaranteed rate for the year. If the index doesn't grow, or the percentage you'd receive is lower than your guarantee, you receive the guaranteed rate. These types of annuities also come in deferred or immediate annuities. You take a series of payments immediately in an immediate annuity. You simply allow the money to grow in a deferred annuity.
Check the fees and penalties. Most annuities have early withdrawal penalties from the company, in addition to the federal 10 percent penalty for early withdrawal if you're under 59 1/2. See if the companies offer partial withdrawals at no fee, some offer a 7-year or less surrender fee with partial 10 percent cumulative withdrawals. That means that if you end up with a lousy rate or bad returns, you can make a tax-free direct transfer to another annuity of at least part of your funds in the early years and all of them in a shorter period.
Focus on the historic returns. If you have a fixed annuity, you're at the mercy of the company after the guaranteed rate. Some companies offer a huge upfront rate and then miserable rates in the later years. If you select a variable annuity, check historic returns for the funds and make sure a number of funds exist from which to select if the ones you choose prove to be dogs. Compare the guaranteed rate also for the indexed annuities. Depending on the market conditions and the index it follows, you may be receiving that rate in most years. If you take an immediate annuity, simply compare your payments.
Select an annuity that is most age appropriate. If you're younger, you have more potential of losing buying power through inflation if you have a fixed annuity. Often the returns don't keep pace and you'll find the growth is less than inflation. The older you are, the more the fixed annuity makes sense, particularly if you are a conservative investor.
Consider the cost of the bells and whistles. Some variable annuities offer guarantees on returns but these come at a price. Read each guarantee carefully to see if it's the right one for your purpose. Some of them require you take the funds in a specific manner or leave the money in for a specific length of time. Most of them cost between one percent and a fraction of a percent calculated in basis points.