What Are the Pros and Cons of an Index Annuity?


Quick Answer

Index annuities offer safety, tax-deferred growth, access to growth in the stock market with minimal risk and a higher return than CDs, bonds and money market accounts in most cases. Potential disadvantages include an IRS penalty on early withdrawals, ordinary income tax on earnings and the lack of FDIC insurance.

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Full Answer

While index annuities offer enough risk to merit interest income higher than federally insured deposits, they are backed by state-regulated insurance companies. These companies generally invest in bonds between the ratings of A and AAA, so growth is possible while risk is minimized. The annuities also serve as a form of life insurance, with guarantee options surrounding a death payout. Once the owner reaches 59 1/2 years old, he has flexibility when it comes to withdrawals. There's no limit to contributions, and inheritance passes directly to heirs without going through the probate process. The lifetime option turns the annuity into income that is impossible to outlive.

While these annuities do provide some growth, there are other vehicles that take advantage of more growth in the stock market. Additionally, when the owner does start withdrawing, the proceeds are taxed as normal income. Even after the age of 59 1/2, the owner is only allowed to withdraw up to 10 percent of the balance without incurring a tax penalty.

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