Tax-free investing: whether fixed or variable, annuities may be just the thing for your portfolio.

Whether fixed or variable, annuities may be the thing for your portfolio

Looking for an investment vehicle that doesn't have tax obligations? Try an annuity.

You don't have to declare annuities on your tax return or pay income tax on the earnings. Since earnings are tax-deferred, you have more money earning interest for you, and hence it grows much faster.

Annuities are available primarily through insurance companies. You can set up a contract that will provide you with an income on a monthly, quarterly or annual basis for a specified number of years, or for life. But whether an annuity is right for you depends on your investment goals and your age.

Fixed annuities guarantee a fixed rate of return on your investment, while the interest rate on variable annuities fluctuates. There are other types to choose from, including deferred annuities, which can be fixed or variable; single premium annuities, which are purchased with a lump sum payment; and flexible premium annuities (these are available only if you work at a nonprofit institution or school).

Variable annuities invest in mutual funds, so your money has greater potential for increasing. But there's also greater risk because of market fluctuations. Glenn Daily, a fee-only insurance consultant in New York, says that expenses are higher with variable annuities than typical mutual funds because of the additional 1% to 1.25% insurance charge. "You pay the fund expense plus the additional charge," he explains. "I suggest investing in no-load mutual funds." As a quick rule of thumb, Daily says, don't bother with a variable annuity unless you use it as a source of income in retirement.

Although annuities are provided by insurance companies, they are marketed and sold through brokerage firms, banks and other financial institutions, even financial planners. There has been some concern about variable annuities sold through banks because fees and other charges undermine the annuity's tax advantage.

Instead, look for low-cost annuities, called low-loads or no-loads, which typically cost less than bank annuities. Check out Variable Annuity/Life Performance Report ($45; 800-876-5005). Look into fixed-rate annuities from a number of insurers by getting a copy of the Annuity and Life Insurance Shopper ($20; 800-872-6684). But consider the insurer's rating before investing. Also, you may want to investigate interest rates and surrender charges (the fee you pay when bailing out of the fund).

If you're interested in a black-owned insurance company that sells annuities, call the North Carolina Mutual Life Insurance Co. in Durham (800-626-1899). The company is licensed to sell annuities in 20 states and the District of Columbia.

Besides choosing a fixed or variable annuity, there are a number of other choices to make. Annuities are similar to IRAs, says Cheryl Broussard, author of The Black Woman's Guide to Financial Independence. "They're primarily an investment for retirement, but you can put in a lot more money than you can put in an IRA," she says. In fact, there is no cap on the amount that can be invested in an annuity.

Annuities are generally preferable to regular IRAs, says Kieran Delamere of the Daniels Agency in Pawling, New York (800-338-5702). "If you have an IRA and you're not happy with the rate of return, an excellent idea is to roll it over into a variable annuity," says Delamere, who is a registered representative with Aetna Life Insurance and Annuity Co. "You also have the benefit of moving in and out of several mutual funds without being charged transaction fees." Minimum investment requirements are typically $1,000 to $5,000, or a small monthly contribution of $100.

Annuities, however, are not recommended for younger investors who may need to get to their cash fast. The investment time frame is at least seven years, and there are stiff fees (a hefty 10% tax penalty) if you withdraw before age 59 1/2. When shopping around for an annuity, look into the insurer's penalty schedule. Many start out at 7% and decline by one percentage point a year. The initial surrender charge should not exceed 8%.

There are perks associated with annuities. Some have loan programs that allow you to get to your money without paying any penalties. Delamere describes how one such program works. "The investor can take out up to 50% of the value of the annuity, and the money can be used for any reason. No fees are charged if the money is paid back within five years, or within 20 years if the loan was used to purchase a primary residence." The money you take out as a loan will not be taxed. But such loan provisions are offered primarily to employees of nonprofits or school districts.