Does a Fixed Annuity Make a Good College Savings Investment?
Drawbacks and Rules for Using a Fixed Annuity to Save for College
For many parents, a child’s college account is the last place they want to take big risks in the stock market. This aversion towards risk becomes even more pronounced when there are only a few years left until the money needs to be tapped for tuition. The last thing anyone would want to have to tell their child, is that they can’t go to the school of their dreams because mom or dad picked the wrong mutual funds!
This leaves many parents fighting for a competitive yield on fixed income investments such as CD’s, bonds, and money market accounts in the final years before college. So naturally, when someone at a cocktail party starts talking about the very attractive interest rate they’re getting on a tax-deferred fixed annuity, ears are bound to perk up.
But the reality is, a fixed annuity with all its rules just isn't right for everyone. Before you cash in your Section 529 account and buy a fixed annuity, here are some important facts to consider:
Taxes and IRS Penalties on a Fixed Annuity:If you are under age 59 1/2 when you withdraw the funds from a fixed annuity, all gains are going to be taxed as ordinary income and be subject to an additional 10% penalty. If you’re over age 59 1/2, then there is no 10% early withdrawal penalty, but the income is still subject to ordinary income tax.
This means that, in a worst-case scenario, over 40% of your earnings will go back to Uncle Sam.
That can sure make the higher interest rates on fixed annuities look a lot less attractive.