Considering the pros and cons of an annuity, you should think about investing in one after you have fully benefited from other retirement products that offer tax benefits as well, for example, IRA and 401(k) plans. You should consider annuities only if you have a little extra money to invest and save for your retirement, even more so if you belong to a higher tax slab, to benefit from the tax-free growth of your money.
The reason for that simply is that you may face some problems with an annuity. Annuities are costly, and do not allow you to comfortably make withdrawals. A withdrawal is discouraged by a 10% penalty, and a surrender charge, the rate of which may range from 7 to 20%, depending on your product. Moreover, you would also have to pay up to 10% in commission to the agents who sold you the annuity plan. And with all the costs added up, the annual charges of an annuity amount to 3%, which is even higher than that of a mutual fund.
And speaking of mutual funds, evaluate your available investment opportunities before you invest in an annuity. An insurance agent will do his or her best to convince you to buy the annuity by propagating only its benefits, as the annual costs and rules are often very complex and hard to understand. Don’t get easily impressed and extract as much information about the product as possible. Also check mutual funds out, learn about their costs and returns and research their terms and conditions, maybe you would be better off managing your own funds and generating an income stream.
You must also understand the rules and regulations about the withdrawals. Only the earnings on your investment will be taxed, and your contribution to the annuity. The maximum tax rate these days is 35%, and you can be sure these rates will not increase any time soon.