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An annuity is a contract with an insurance company: you pay money, and the insurer agrees to make payments to you, either right away or at some point in the future. Annuities can help with retirement income, but they come with costs and restrictions worth understanding first.

What types of annuities are there?

A fixed annuity credits a stated interest rate. A variable annuity invests in sub-accounts, so its value rises and falls with the markets. An indexed annuity ties credited interest to a market index, usually with limits on gains and some downside protection. An immediate annuity begins paying shortly after purchase, while a deferred annuity grows first and pays later.

How are annuities taxed?

Earnings inside an annuity grow tax-deferred. When you take money out, the earnings are generally taxed as ordinary income rather than at capital gains rates. If you buy an annuity with after-tax money, part of each payment is treated as a tax-free return of your original investment. Withdrawals before age 59½ may also trigger a penalty on the taxable portion.

Should I put an annuity inside an IRA?

An IRA already provides tax deferral, so you do not gain additional tax deferral from the annuity. People sometimes choose one in an IRA for the guaranteed income features or other benefits, not for tax savings. Make sure those features justify the cost.

What fees should I watch for?

Possible charges include surrender charges for early withdrawal, annual contract fees, mortality and expense charges, investment fees on variable annuities, and extra fees for optional riders. Ask for a written list of all costs before you buy.

What are the advantages?

• The potential for income you cannot outlive
• Tax-deferred growth
• Optional death benefits for heirs

What are the drawbacks?

• Limited access to your money, especially in the early years
• Often higher costs than other investments
• Ordinary income tax on earnings
• Guarantees depend on the financial strength of the issuing company

What should I ask before buying?

Ask how the product pays you, what it costs, what happens if you need your money early and how the insurer is rated. Compare alternatives, and be wary of any sales pitch that rushes you. Regulators such as investor.gov offer guides for evaluating annuities.

If you are weighing an annuity, contact us and we can walk through the tax consequences with you.