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What are the pros and cons of an annuity?

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Quick Answer

The main advantage of an annuity is its tax-deferred status, allowing a contract owner to invest retirement savings with no contribution limit and no taxes until the funds are withdrawn, reports CNN Money. Disadvantages include broker's commissions, annual fees, surrender charges and IRS penalty taxes for early withdrawals.

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Full Answer

IRA and 401(k) accounts have maximum annual contribution limits, but contract holders of annuities can contribute an unlimited amount of funds, according to CNN Money. There are no annual taxes until the funds are withdrawn, when gains and interest are subject to normal income tax, states Forbes. Fixed annuities have principle protection by the insurance companies that issue them. Account holders can receive payments in lump sums or guaranteed payments for agreed-upon periods of time, as reported by CNN Money.

Annuities often have high annual fees that cover investment management and insurance, states CNN Money. Contract holders are expected to keep investments in annuities for many years and pay high surrender fees to insurance companies if they prematurely withdraw funds. The IRS also charges a 10 percent penalty tax if retirement funds are withdrawn from annuities before the contract holder is 59 1/2 years old. Because insurance salespeople receive large commissions for sales of annuities, they often attempt to sell them to clients without fully disclosing the disadvantages, reports Forbes.

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