Annuities offer a long-term investment option

Annuities have become a popular investment vehicle. Physicians may find them attractive because they can be used as an asset protection tool. And those who need to sock away extra money for retirement may like investing in annuities -- as long as they don't need immediate access to their money.

Annuities are essentially contracts between an investor and an insurance company to grow retirement money while deferring taxes. In at least 14 states, annuities are protected from creditors, meaning they can't be touched in cases such as bankruptcy or malpractice judgment.

But the key word is "deferring." The money you contribute may initially be tax-free, but once you take money out of an annuity, you're hit with income taxes on it. Add another 10% penalty if you take the money out before age 59½.

An annuity, like an IRA, can't be touched until then without penalty. But unlike an IRA, or a 401(k) plan, there's no maximum to what investors can put aside in an annuity.

An annuity can be a good investment, "but it certainly is not a panacea of investments, and certainly no doctor should be taking all of their money and putting it in annuities," said Marc Singer, a partner of Singer Xenos Wealth Management in Coral Gables, Fla., a firm that has mostly physician clients.

Annuities have become a hot commodity. Assets in the most popular type, variable annuities, increased by 20% to about $985 billion in 2003 from 2002 figures, the U.S. Securities and Exchange Commission said in June.

However, the SEC, in a joint report with the National Assn. of Securities Dealers, has warned that some brokers have been overly aggressive in marketing these products, selling annuities to investors without adequately informing them of the nature of the investments. The SEC and the NASD warn that the investments are "not appropriate for short-term goals" because of their tax implications and potentially high surrender charges, the charge a broker imposes if an investment is withdrawn within a certain number of years.

How annuities work

Annuities can be broken down into two categories: deferred and immediate. An immediate annuity involves giving money to an insurance company in exchange for a payment for the rest of your life. Singer said this kind is increasingly uncommon because it has little flexibility and "may not keep pace with what's going on in the real world."

More typically, he said investors seek out deferred annuities, which allow an investor to give money to an insurance company and let it grow tax deferred. Taxes aren't paid on the money invested as long as it stays in the annuity. Among deferred annuities, there are two major types: fixed and variable, which refers to the rate of return on the investment.

Singer said a typical fixed annuity currently averages about 3% to 3.5%. The fixed rate is set for specified period, usually one to 10 years, and at the end of the term, the investment renews at a rate dictated by the insurer.

Some investors may appreciate fixed annuities for the security that they provide, said Hugh Smart, an attorney and director of advanced planning for Allstate Insurance in Northbrook, Ill. But Singer said he almost never recommends fixed annuities because the interest rates are so low "they're not viable as retirement vehicles."

The other option is a variable annuity. It's like a mutual fund within an insurance company, with rates of return fluctuating with the stock market. Some may see returns of more than 30%, though typically investors should figure on returns of about 6% to 8%, said Mark Mackey, president and CEO of the National Assn. for Variable Annuities in Reston, Va.

To attract market-skittish investors, some variable annuities offer extra features to put investors' concerns at ease including death benefits to pass on payments to beneficiaries and guarantees that set a floor for income after a certain time with the investment.

These extras, called riders, can cost additional money on top of the fees associated with annuities. Tom Nicoski, vice president and senior product manager for the securities firm RBC Dain Rauscher Inc., in Minneapolis, said riders can range from 0.25% to 0.60% while another charge with variable annuities for insurance and mortality expense can cost 1.35%.

There is also going to be a management fee for the account from 0.2% to more than 1%, he said. All together, that means fees of around 2.5% on investments -- more expensive than mutual funds.

So why an annuity?

The major attraction of annuities is a sense of security. If there's money you want to make sure you don't touch until retirement, you can lock it in an annuity. When it comes time to take out the money, you can take it in one lump sum, or take annualized portions to spread out the income tax burden, and control your retirement spending.

Smart recommends investors first max out their contributions to their qualified retirement plans, such as 401(k)s, to take full advantage of their tax-saving characteristics. Then, he said annuities can be used on top of them to save additional amounts.

"The advantage for annuities for retirement is that there are no limits on how much can be contributed on an annual basis," said Smart.

Adds Nicoski, "Where it works best is for someone who is trying to catch up to help supplement their retirement savings," Nicoski said. "It's a nice growth vehicle for someone in their late 40s or 50s. They are in their peak earning years and they have more money to invest."