Inflation risk, tax implications and basis considerations can all present financial issues with annuity instruments, depending on the circumstances of the investor, notes CNBC. An annuity is an insurance product that pays out income and can be used as part of a retirement strategy, CNN Money reports.
Rising economic inflation reduces an investor's purchasing power, according to Chron. With annuities, an investor locks in a certain interest rate that determines future annuity payments. If this rate is growing at a slower rate compared to inflation, the investor can suffer a financial loss. This problem exists with fixed annuities, and investors should always monitor interest rates to see when they normalize, CNBC explains.
Ordinary income taxes apply to all gains associated with annuities, reports CNBC. This realization is even more prevalent with variable annuities. The size of annuity payments varies based on multiple factors, including length of payment period and whether the annuity is fixed or variable. Payments can be either monthly, quarterly, annually or a lump sum, notes CNN Money.
Transferring an annuity to a descendant results in a step-up in cost basis, CNBC explains. For annuities that appreciate significantly, this step-up in cost basis does not apply, which can result in considerable tax implications for the recipient of an annuity. This condition can make it difficult to justify transferring an annuity to a friend or family member.