BOSTON — To the life insurance industry, there is nothing new about giving savers a place to put their money. For many years, one of the more popular vehicles for long-term capital appreciation has been the annuity.
The lures of tax-deferred interest, monthly checks for the rest of your life, and guaranteed principal have long been enough to attract millions of people to invest in annuities for retirement. Those lures, however, were also enough to attrct many wealthy people who only wanted to use them for short-term tax shelters. They would open the annuity, watch the interest build-up free of taxes, and take the money out after a few years.
While the annuity is not new, there are some new versions coming along.
Last year's attempt by Congress to close up some gaping loopholes in the tax system ended the annuity's attraction as a short-term shelter. Under the Tax Equity and Fiscal Responsibility Act (TEFRA), there is now a 5 percent tax on any withdrawals made within 10 years of purchase. The penalty is lifted at age 59 1/2.
This penalty tax is in addition to the ordinary income tax you would pay on the money taken out of the annuity. It is also in addition to any early-withdrawal penalties the insurance company may impose. Insurance companies normally impose peanlties on money withdrawan during the first five to 10 years ofo annuity ownernship.
Despite these penalties and the lure of individual retirement accounts (IRAs) , where there is more flexibility in choice of investments, the insurance company annuity still has some good features. But with about 900 companies offering a wide variety of products, it is necessary to shop carefully.
There are two basic types of annuities: variable and fixed. There are also two different types of annuity premium payment methods: flexible and single.
Variable annuities have no guaranteed interest rate, but pay a rate based on whatever is in their pportfolio of stocks, bonds, or money market instruments. With some variable annuities, the investor chooses one of these instruments and stays with it. With others, known as wraparounds, some or all of the money can be moved to different investments, depending on what seems to have the best return at the time.
In a fixed annuity, the company guarantees a specific rate -- currently averaging 10 to 11 percent -- usually for one year, although there are companies that offer a guaranteed minimum rate for up to five years. In these cases, the company will promise to pay no less than a certain percentage, such as 10 percent, and may pay more, if interest rates go up.
In a fixed annuity, the portfolio usually consists of long-term, high-grade corporate and government bonds.
The two kinds of premium payment methods make annuities available to a wide variety of people. With a flexible premium annuity, you can start with a small amount, perhaps $250, and add small amounts every month, such as $25, $50 or $ 100.
Because the insurance company has less money and more paperwork with this type of annuity, it will pay a slightly smaller interest rate than oon the single-premium variety. On a single-premium annuity, the policy is purchased for a lump sum, usually no lower than $5,000 but seldom more than $250,000. You cannot add any money to this policy. Instead, you must purchase another annuity. The interest rate is guaranteed for a little longer, usually at least two years.
Since the passage of TEFRA and its stiff early withdrawal penalties, a few companies hve devised what is becoming known as the "post-TEFRA" annuity. The idea behind this version is to let policyholders take at least partial advantage of higher interest rates, even though they may be locked into a lower rate. Kemper's "Kemper Choice," for instance, has a fund with a guaranteed rate and another fund pegged to a more short-term index, like three-month Treasury bills. Money can be moved between funds without risking a penalty or additional taxes.
One of the major questions surrounding annuities concerns safety. Since the liberalization of IRAs, people are now able to put up a $2,000 a year in a retirment kitty. And if they put it in some sort of bank account or certificate , they have the security of federal deposit insurance. Still, for those who can save more than $2,000 or want more flexibility of investments without changing companies, the annuity is an attractive alternative.
One way to gauge safety is through ratings published by A.M. Best Company. But Best's information can sometimes be a year old. For this reason, several brokerages whose agents sell annuity products have built up rating departments of their own. A check with some of these firms may help find the strongest companies. Also, the Lipper Analytical Survey of fixed-income and variable annuities keeps track of the best performers over the years.