Why should you buy this plan?

On the face of it, the annuity plans look quite an attractive choice for investors. They are more like mutual funds incorporating some features of the life insurance products. Because of the insurance kind of feature in the annuity, the payments from the plan are tax-deferred. The biggest reason for buying an annuity plan is the feature of tax-deferral inherent in these plans.

However, it will be wrong to go in for annuity plans for the sole reason of this feature, as the high cost of the annuity plans may make this choice less favorable than a comparable mutual fund. They must be evaluated appropriately against the other means of investment windows available to an investor, for example stocks, bonds, mutual funds, stock-bond portfolio or insurance products based on the different kinds of possible scenarios emerging during the life of an investor.

Annuities are generally meant for long-term investors, because there are huge exit charges imposed as penalty on the investors if they decide to terminate the plan prematurely up to a certain period. There is also the tax charges imposed on the investors if there is a premature withdrawal from the account before the age of 59-1/2 years. In premature withdrawals the payments are treated as ordinary incomes. In such situations, there is no advantage of lower tax on capital gains available to investments made in stocks.

Though they are capable of providing a fixed income in most of the cases during the life of an investor, these instruments do not have the liquidity of a comparable fixed income product, like bond, in the market with the result that in a rising interest rate markets, they will be less valuable to possess as compared to a bond. A bond can be sold in the market when interest rates are rising thus giving a higher rate of return comparable to the prevailing interest rate in the economy. However, because of the restrictions on withdrawal and additional charges on withdrawal, the same kind of benefit cannot be derived in case of an annuity.

There are some tax deferral retirement accounts, which offer higher earnings as compared to annuity plans. These plans earn even more than the variable annuity plans because the investment in retirement accounts is pre-tax, whereas the investments in the annuity plans are from post-tax earnings. So the investor should go in for the annuity plans only after the maximum amount that can be allowed in such retirement account has been invested in the same.

One needs to start early in the plan for the tax-deferral feature to have value addition to the investor as compared to mutual fund investments. Moreover, unless one decides to hold the annuity plan for a considerable period of time, for example 15 years or more, these plans, including the variable annuity version, do not outperform the mutual funds because of withdrawal restrictions and high cost. In addition, higher the tax bracket of the investor, higher is the period for which the annuity is required to be held for its tax-deferral feature to have any advantage. So, if you are in a lower tax bracket, you need to value other options more carefully. Another aspect that needs to be looked into is whether the plan is primarily meant for the investor or his heirs, and do the heirs also enjoy the same kind of tax breaks as the investor himself.