Becoming A Mompreneur
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ANNUITIES ARE A big favorite of many brokers and financial planners. And it's no wonder: They're easy to sell because they sound so safe and easy a diversified, tax-deferred investment that is protected from losses in case you die. They also can generate fat commissions for the folks who sell them. You can guess which part the planners emphasize to their clients. Our advice? Except in a few limited instances (which we'll discuss in a minute), there's really no point in buying an annuity. You can get the same returns and tax benefits from a mutual fund held in your IRA or 401(k). And the no-loss insurance is not worth the exorbitant fees you're normally asked to cough up. To see why, you first need to understand how an annuity works. Annuities generally come in two varieties: fixed and variable (there are others, but these are the ones you will most likely encounter). Insurance companies (through brokers) sell them as a sort of combination retirement account/insurance policy. You put your money in, and the principal is allowed to grow, tax deferred, for a set period usually until you're 59 1/2. Then, you either "annuitize" what's in your account (which means you get steady payments over a fixed period of time) or you can take a lump-sum distribution (which could leave you with a hefty tax bill). In either case, you'd better be comfortable with the decision. Most of the time, you can't change your mind. A big part of the pitch, however, is the death benefit. If you die and your account has dropped below what you originally put in, the insurance company makes up the difference to your beneficiary. But don't be fooled: The death benefit is triggered in only three of every 1,000 variable-annuity accounts, according to Limra International, an insurance-industry research group. The difference between fixed and variable annuities is that the "fixed" contract guarantees you a set interest rate during what is known as the "accumulation period" the time before you take withdrawals. Oftentimes, however, if you read the fine print, you'll find that the great rate that's being plugged only lasts for a brief period. After that, it can change dramatically, although there may be a minimum interest-rate guarantee. With a variable annuity, the return is based on your choice among a set of mutual funds, bonds or cash-equivalent investments that is usually predefined. Because of this relative flexibility, variable annuities are by far the most popular type of annuity. And you can expect your broker to pump up the idea that the rate you earn is up to you. Pros
The one big perk of an annuity is that, unlike an IRA or 401(k), it doesn't limit the amount of cash you can put in at any one time. That means if you max out your regular retirement plans in a given year but still have a chunk of money you want to sock away for retirement you might consider buying a low-fee variable annuity. Fortunately, a few have become available over the past few years. T. Rowe Price, for example, offers annuities with 0.95% annual expenses (for the insurance and the funds). And Vanguard's fees are as low as 0.48%. (For a more detailed discussion of when a variable annuity might be right for you, see our article "Who Should Buy Variable Annuities?".) Cons
As we've noted, most annuities are notorious for the high fees they charge. On average, you'll pay about 2.35% in basic fees for a variable annuity, compared with 1.42% for the average mutual fund. And many variable-annuity providers tack on additional fees on top of that, like an annual "contract charge." Another problem is the taxes. Withdrawals from variable annuities are taxed as ordinary income, which can run as high as 35%. But mutual-fund shares held in taxable accounts for more than 12 months are taxed at the lower capital-gains rates, which means you won't owe more than 15% to Uncle Sam. Moreover, if you die still owning the annuity, your beneficiary could owe income tax as well as estate tax on the proceeds. That's not true of mutual funds.
ANNUITIES ARE A big favorite of many brokers and financial planners. And it's no wonder: They're easy to sell because they sound so safe and easy a diversified, tax-deferred investment that is protected from losses in case you die. They also can generate fat commissions for the folks who sell them. You can guess which part the planners emphasize to their clients. Our advice? Except in a few limited instances (which we'll discuss in a minute), there's really no point in buying an annuity. You can get the same returns and tax benefits from a mutual fund held in your IRA or 401(k). And the no-loss insurance is not worth the exorbitant fees you're normally asked to cough up. To see why, you first need to understand how an annuity works. Annuities generally come in two varieties: fixed and variable (there are others, but these are the ones you will most likely encounter). Insurance companies (through brokers) sell them as a sort of combination retirement account/insurance policy. You put your money in, and the principal is allowed to grow, tax deferred, for a set period usually until you're 59 1/2. Then, you either "annuitize" what's in your account (which means you get steady payments over a fixed period of time) or you can take a lump-sum distribution (which could leave you with a hefty tax bill). In either case, you'd better be comfortable with the decision. Most of the time, you can't change your mind. A big part of the pitch, however, is the death benefit. If you die and your account has dropped below what you originally put in, the insurance company makes up the difference to your beneficiary. But don't be fooled: The death benefit is triggered in only three of every 1,000 variable-annuity accounts, according to Limra International, an insurance-industry research group. The difference between fixed and variable annuities is that the "fixed" contract guarantees you a set interest rate during what is known as the "accumulation period" the time before you take withdrawals. Oftentimes, however, if you read the fine print, you'll find that the great rate that's being plugged only lasts for a brief period. After that, it can change dramatically, although there may be a minimum interest-rate guarantee. With a variable annuity, the return is based on your choice among a set of mutual funds, bonds or cash-equivalent investments that is usually predefined. Because of this relative flexibility, variable annuities are by far the most popular type of annuity. And you can expect your broker to pump up the idea that the rate you earn is up to you. Pros The one big perk of an annuity is that, unlike an IRA or 401(k), it doesn't limit the amount of cash you can put in at any one time. That means if you max out your regular retirement plans in a given year but still have a chunk of money you want to sock away for retirement you might consider buying a low-fee variable annuity. Fortunately, a few have become available over the past few years. T. Rowe Price, for example, offers annuities with 0.95% annual expenses (for the insurance and the funds). And Vanguard's fees are as low as 0.48%. (For a more detailed discussion of when a variable annuity might be right for you, see our article "Who Should Buy Variable Annuities?".) Cons
As we've noted, most annuities are notorious for the high fees they charge. On average, you'll pay about 2.35% in basic fees for a variable annuity, compared with 1.42% for the average mutual fund. And many variable-annuity providers tack on additional fees on top of that, like an annual "contract charge." Another problem is the taxes. Withdrawals from variable annuities are taxed as ordinary income, which can run as high as 35%. But mutual-fund shares held in taxable accounts for more than 12 months are taxed at the lower capital-gains rates, which means you won't owe more than 15% to Uncle Sam. Moreover, if you die still owning the annuity, your beneficiary could owe income tax as well as estate tax on the proceeds. That's not true of mutual funds.
