Questions to ask Before Purchasing an Indexed Annuity

An annuity is an agreement or contract between a consumer and an insurance company where you make either a lump-sum payment or a series of monthly payments to fund it. The company agrees to make specific, periodic payments, usually after you retire.

Annuities are good retirement savings vehicles and usually offer safe, tax-deferred growth. Most include a death benefit that pays out a specific minimum amount, such as the total amount you have paid in. As long as you wait until retirement, the gains you make in the annuity are taxed at ordinary income rates, not capital gains rates.

Annuities are offered in three main types. A fixed annuity pays a specific amount of interest and agrees to pay a specific, fixed amount, based on the dollars in the account. The time period of the payments is also fixed. A variable annuity uses different investment options to invest the payments, usually stock mutual funds.

A good compromise is an indexed annuity, which has a return based on a financial index, like the Dow Jones Industrial Average. While the return is based on the index, indexed annuities provide a minimum payout, regardless of performance.

Here are some questions to ask before purchasing an indexed annuity:

What are the costs or fees involved?
Many fees are assessed on annuities, including mortality and expense risk charges, administrative fees and underlying fund expenses. These can add up to several hundred dollars a year and reduce your return. Check for fees for other added benefits, like extra death benefits or long-term care insurance.

What are the tax benefits?
Check your tax professional as to how the annuity payments will affect your tax liability after retirement.

What is the term, when will the payments start?
Be sure to understand when the payments will start, and how long they last.

How much will the payments be?
Review the payments and be sure you are funding the annuity adequately. Annuities are a good, conservative retirement investment.

What is the death benefit?
Review the death benefits for your spouse and family. Review any extra coverage or upgrades and make sure they are worth the cost.

Can I access the money early if I need it?
Withdrawing the money early will involve surrender fees, plus you will pay a higher tax rate. You may also have a tax penalty, in addition to the taxes due.