It seems that everyone wants to sell you an annuity for every situation. While annuities sound like safe investment options, they aren’t nearly as good as they sound. Annuities are often complicated legal contracts that consumers do not fully understand. People just don’t know what they’re purchasing. In essence, you are giving up control of your money for many years, in exchange for a guarantee that you will get all your money back with some interest. The good part is that you are not taxed on the gain until you start withdrawing your money. The bad part is that the gain is always taxed no matter who gets the money or when. The really bad part, especially for seniors, is that if you need to withdraw more than the contract allows, the guarantees go away and you must pay a steep penalty for the privilege of getting your money back.
One would never invest in an annuity if you knew at the beginning that you would need most of your money back before the term of the contract allowed for it. Unfortunately, people rarely anticipate bad things happening to them when they purchase an annuity. You may experience health problems 5-10 years after you purchase your annuity; unfortunately, that’s when seniors need a lot of cash, and that’s when they learn about the consequences of an annuity.
Generally, annuity salespeople receive hefty commissions. If your sales person received a high commission, then you may have a longer penalty period and a higher penalty for taking your money out early. In addition, taking your money out early results in the disappearance of all the guaranties promised in your annuity contract.
While not all annuities are bad, most annuities are not good investments, particularly for seniors. Annuities frequently pay low interest rates and make little money compared to other investment options. In addition, other investment options may have more favorable tax implications than an annuity. There is no income tax inside of an annuity. Instead, much like an IRA or other qualified money, the gain is not taxed while it’s accumulating (known as a deferral), but it is taxed as ordinary income when you withdraw your money. At that time, you will pay income on the gain (and not the principal on the investment). This gain is taxed at higher ordinary income tax rates rather than lower capital gains tax rates. Therefore, if your spouse should die, you will not receive a tax break on this investment. You will pay ordinary income tax on the deferred gain, rather than receive a “step up in basis.”
To illustrate, imagine purchasing Microsoft stock for $10 that you hold on to until your death. When you pass away, this stock is worth $1,000. Your spouse would receive a “step up in basis” at your death, and he or she would pay no capital gains taxes on this investment. This is a far better tax strategy than an annuity, where you will always have to pay income tax on the gain inside the annuity.
Some annuities are very good for the right client, but typically seniors are presented with those that have hefty penalties if you need to get your money back within a certain period of years. For this reason, look at alternative investments and visit your financial advisor to determine the best investment strategy for your particular situation.
If you have questions about annuities for seniors, Medicaid, or Veterans benefits, consider W.G. Alexander & Associates – we offer a unique blend of asset protection, Elder Law and estate planning. You can also attend our free seminars or call us at (919) 256-7000.