Annuities: choosing a suitable annuity? Beware, it's a minefield out there!

An annuity is an investment vehicle sold primarily by insurance companies. In its most secure form, the fixed annuity, it addresses the risk that an investor will out-live a lump sum they have accumulated. In this way it can protect against premature poverty, much as life insurance protects against premature death.

Annuities are especially popular in retirement planning.

Several types exist, however every annuity has basic properties: the payout can be immediate or deferred, the returns can be fixed or variable and it can be paid for periodically or with a lump sum.

Once annuity payments begin, except for bonuses, they do not usually change, even to reflect inflation. An annuity investor usually has two choices for the term of the payment stream:

1. A fixed period, for example ten years, meaning that payments will be made for ten years to the investor (or heirs). These payments generally include principal and interest.

2. Annuitize, meaning the insurance company will pay periodically until death. Depending upon the policy choice, the heirs do not receive anything back.

Immediate payout: An annuity with an immediate payout will usually begin paying to the investor either immediately or, depending upon the insurance company, 12 months from the date of purchase.

Deferred payout: Deferred payout means the investor will receive payments at an agreed later date, for example at retirement.

Fixed annuity

The basic premise of a fixed annuity is that the investor pays a sum of money to an insurance company, and in exchange they promise to pay the investor a fixed month********for a certain period of time. annuity with a fixed return offers a guaranteed return by investing in low-risk securities like government bonds. A fixed annuity can be thought of as a kind of re verse life-insurance policy, protecting against poverty during your life.

Variable annuity 

A variable annuity is essentially an insurance contract combined with an investment product and therefore provides a variable return because it is dependent upon the underlying investment--usually stock and bond portfolios.

A variable annuity usually has no predetermined rate of return, but can offer a possibly higher rate of return when compared with a fixed annuity. A variable annuity is especially attractive to a high earner trying, perhaps late in the game, to save aggressively for retirement.

Tax

In Switzerland the lump sum invested for an annuity is generally subject to a 2.5 per cent stamp duty. But during the withdrawal period only 40 per cent of the annuity income is taxed, together with the investor's annual income.

This appears advantageous but it should be remembered that part of the annuity income is previously taxed income and not only untaxed capital growth.

Should you buy an annuity?

Annuities are extremely profitable for the companies selling them--which accounts for their popularity among sales people. But they are not always the right choice for everyone. Unfortunately annuity contracts are very difficult to understand. Before you decide to buy, consider this:

* For a variable annuity, are you willing to take the risk that your account value may decrease if the underlying mutual fund investments perform badly?

* Will you use the annuity primarily to save for retirement, or a similar longterm goal?

* Do you understand all of the fees and expenses that the annuity charges?

* Have you considered all the tax consequences of purchasing an annuity, including the effect of annuity payments on your taxable income in retirement?

* Do you want the annuity to name beneficiaries in the event of your death?

Finally

Financial professionals who sell variable annuities have a duty to advise you as to whether the product they are offering is suitable to your investment needs.

Be sure to ask questions and write down the answers for future reference. Before purchasing a variable annuity, you owe it to yourself to learn as much as possible about the investments on which they are based, the benefits they provide, and the charges you will pay.

Once you have decided on the type of annuity and amount to invest, we recommend your independent financial adviser provide you with at least three comparisons from larger, established insurance companies.

Brien Donnellon

Brien Donnellon is the owner of KEY INVESTMENT a Swiss registered, financial services company formed in 1997, which provides financial advice and solutions for expats and HR departments. The company is authorised and regulated by the Swiss Federal Banking Commission.

www.keyinvestment.ch Email: [e-mail]