A tax-deferred annuity is an investment vehicle used by an individual planning his retirement income. It is sold by insurance companies, and it offers fixed or variable rates of return. A tax-deferred annuity grows tax-free until retirement. The funds accrue through monthly premiums and get converted into monthly payments made to the individual at retirement. Tax-deferred annuities can benefit many individuals; however, every potential investor should be aware of their drawbacks.
Income for Life
Tax-deferred annuities offer an investor income for the remainder of her life. Whether the annuity is a fixed or variable annuity, it protects the investor against any losses and guarantees a minimum monthly payment. The investor also can choose a lump-sum payment option. Annuities tend to perform better than other types of investments during economic downturns.
The funds an investor puts into a tax-deferred annuity gets compounded every year and isn't taxed until he withdraws them. Since it is likely that the investor will be in a lower tax bracket when he retires, this is an important benefit when he finally withdraws the funds. An additional benefit is that the principle in the annuity earns interest, and the interest earns interest as well.
Tax-deferred annuities have high maintenance fees, which may make them costly investments. Fees are assessed for any additional feature or benefit that an investor adds to his plan. There are annual fees, deposit fees, mutual fund management fees and insurance fees. The fees accumulate and may reduce the profits an investor gains from the annuity. If possible, the investor should look for an annuity with low-load or no-load agreements -- where load or sales fees are low or are not charged -- and other low fees before investing. If an investor needs to withdraw funds early in the life of the annuity, there may not be enough funds to withdraw because the fees and early withdrawal penalties have depleted the account.
Funds placed in a tax-deferred annuity are essentially locked up until retirement; large penalty fees are applied to withdraw funds early from the annuity. If the investor is close to retirement or should need funds from the annuity in the near future, this is not the right investment vehicle.