Annuities are investment vehicles that offer tax-deferred growth of earnings for your retirement. You enter into a contract with an insurance company and make payments to your account that, in most cases, are not tax deductible. Your money either earns a fixed rate of interest on the money, or it is invested in the equivalent of mutual funds, which can grow tax-deferred. The insurance company makes payments back to you at a specified date, at which point you are taxed on any earnings that are paid out to you. Annuities come with hefty upfront fees, commissions and annual expenses. The drawbacks of using annuities often send investors looking for alternative investments.
Individual Retirement Accounts
Traditional individual retirement accounts also offer tax-deferred growth and provide the account holder some control over the investment. Contributions are tax-deductible. Roth IRAs also offer tax-deferred growth, but contributions to them are not tax-deductible. The downside to IRAs include a limit on the amount that may be contributed each calendar year. You must use other investment vehicles in conjunction with an IRA to get the best results.
A mutual fund represents a pool of money from thousands of like-minded investors. The fund is managed by a professional money manager, who invests the money in stocks, bonds and other securities. The benefit of mutual funds over annuities is the ability to move or exchange your money from one fund to another without penalty. Early withdrawal of funds from an annuity may result in a penalty, depending on the annuity type and your contract. Investing in mutual funds through a financial planner enables you to avoid the costly fees and penalties for early withdrawal.
Certificates of Deposit
A certificate of deposit is essentially a loan to the issuing financial institution. CDs offer a guaranteed interest rate. They work well for individuals who are investing with short-term goals. Annuities lock up your income for a long period of time. CDs are shorter in length and are backed by the FDIC. Annuities are not insured by the FDIC and carry more risk as an investment. CDs do not offer tax-deferred growth of earnings.
Many people invest in the stock market with the hope of using dividends as income. Consulting with a financial adviser and building a diversified stock portfolio is another alternative to annuities. By diversifying, you reduce the risk associated with investing in the stock market. Stocks offer instant liquidity. You maintain control over your investment funds instead of giving them to an insurance company to manage for you.
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