Annuity Pros and Cons

We live in a society that wants to stay young forever, so it's no surprise that annuities are a part of retirement planning.

With an annuity, you invest a set amount of money and then get a monthly payment for the rest of your life. So if you're looking to stay young and live forever, a dependable income stream could rank right up there with Botox and the push-up bra.

The problem is that while annuities offer tax-deferred growth on your investment, there are so many hidden fees that actually outweigh the tax efficiency. There are tons of setup and administrative fees as well as steep surrender charges if you need the money before your retirement; annuities sold by insurance companies often carry extremely high fees, so tread carefully.

But if you've put as much money as you can into your 401(k), Roth IRA or traditional IRA, then an annuity could be a great way to continue your tax-deferred savings if you truly understand these products.

So What is An Annuity?

Here's how it works: You give the company from which you're purchasing the annuity a chunk of money, a.k.a. your premium, either in a lump sum or over a period of years. After your premium is paid in full, the company will make regular payments to you either over your lifetime or a shorter, specified amount of time if you prefer.

In many ways, annuities are similar to nondeductible IRAs, says Rande Spiegelman, vice president of financial planning at the Schwab Center for Investment Research. In both cases, you contribute after-tax dollars and the earnings grow tax-deferred until you start withdrawing at age 59-and-a-half. At that time, you'll owe ordinary income tax on the earnings. Both will hit you with a penalty if you withdraw the money before age 59-and-a-half.