When it comes to investing, there is no right answer for everyone. Financial guru Suze Orman warns those saving for retirement that taking action based on finance myths can get you into trouble when reality sets in. As the economic climate begins to change, so will the way that people need to save for retirement.
Understanding the myths and realities of annuities will help you decide if this investment is right for you.
One type of investment that is surrounded by myths are annuities. Understanding what annuities are and how they fit into your own financial plan is essential to making an effective decision regarding whether or not you should invest. Below, we outline some of the sound advice that Orman offers readers on the pros and cons of annuities.
What Are Annuities?
Just as the U.S. government can sell you investments like bonds, an insurance company can sell you investments called annuities. An annuity is a policy between you as the policy holder and an insurance company. There are five main kinds of annuities
- Single premium deferred annuities
- Immediate annuities
- Variable annuities
- Index annuities
- Tax-sheltered annuities
Depending on the type you have purchased, the insurance company provides you with certain guarantees based on the contract.
The key to growing your retirement savings is knowing how different investment strategies fit into your financial plan.
Annuities: Myths vs. Realities
There are many myths that surround this type of investment. Knowing the difference between the myths and realities is important to understanding if annuities are right for you. Orman identifies the myths below:
Myth: You want to own annuities in your retirement accounts.
Reality: Orman does not agree with the strategy of holding annuities within a retirement account. Annuities can be funded with pre or post-tax dollars, so an annuity offers you the same tax-deferring benefits as a retirement account. Though there are exceptions, she says that it does not make much sense to hold a tax-shelter vehicle like an annuity in an already tax-sheltered account like a retirement plan.
Myth: When you have money to invest outside of a retirement account, it is great to invest in a variable annuity because you will not have to worry about taxes every time you buy or sell.
Reality: Orman explains that a variable annuity will only save you on taxes in the short run. Though you do not pay taxes when you buy or sell a mutual fund within the annuity and you do not pay taxes on year-end distributions, there are other tax disadvantages. With variable annuities, you opt for ordinary income tax rates and give up the right to pay capital gains tax rates.
In the end, the best investment options for your retirement plan will depend on your individual financial situation and current investments. If you need help figuring out which investments make sense for you, try a sophisticated annuity calculator, or find out how an annuity fits into your overall retirement plan by using a retirement calculator.
