If you're looking to start an investment portfolio with the hope of one day retiring to a warm, sunny climate, one option to consider is an annuity. Annuities come in a variety of shapes, sizes and pretty colors to meet your needs and level of risk tolerance. As an investment vehicle, annuities offer a number of pros and cons you need to consider before making a purchase.
An investment occurs when you place your money into a product such as a stock, bond, mutual fund or even a home mortgage or bank savings account in the hope of making more money over time. An annuity is a type of investment product sold by life insurance companies. You make regular payments to the company over a period of time, usually several years, which it places in investments of its choosing. Your money earns tax-deferred interest, meaning you pay no taxes until you begin receiving payments. When the annuity period ends, the insurance company makes regular installment payments to you, typically for the rest of your life.
You can purchase a fixed annuity, meaning that you receive a predetermined interest rate that remains the same for the life of the contract. You can also select a potentially more profitable but also more risky variable annuity where your money is invested in things like mutual funds that do not guarantee a specific rate of return. In most cases, you will purchase a deferred annuity where you make payments over a number of years. However, if you come into a large sum of money, you can purchase an immediate annuity to receive guaranteed income for the remainder of your life.
An attractive benefit offered by investing in annuities is the tax deferral feature. Because you won't pay taxes on the interest until you begin making withdrawals, which usually is at retirement when you're in a lower tax bracket, annuities can serve as an effective tax shelter. The fact that annuities provide a guaranteed income for life can also make life during retirement a little easier, no matter how long you live.
Annuities also come with a number of disadvantages. You're typically locking your money up until you reach age 59 1/2, and there can be substantial penalties if you make an early withdrawal. Annuities are known for the hefty commissions paid to the insurance professionals that sell them. Annuities also come with a variety of annual service fees and administrative charges that take a healthy bite out of your investment dollar.