As the country emerges from its hibernation induced by the cold weather over the past few weeks, many people's thoughts are turning to spring. Even though it's a chore, the annual spring-cleaning ritual is a nice way to welcome the longer days and the first buds on the trees, as well as break the cabin fever and let a little fresh air into your home.
Just as getting rid of some unnecessary junk around the house can be good for your personal well-being, taking a critical look at your investments from time to time is extremely valuable. Over the course of their investing lives, nearly everyone has made an investment that, in hindsight, was a bad decision. Yet in some cases, disposing of financial assets that you no longer want or need is a bit harder than dumping an old pair of shoes in the trash. By being careful, you can avoid mistakes that create far more problems than you'd ever believe possible.
One investment that many people have second thoughts about is a deferred annuity. Issued by insurance companies such as Hartford
In some cases, deferred annuities sometimes offer real advantages over other investments. Fixed annuities often pay higher interest rates than FDIC-insured bank CDs and sometimes include desirable options that CDs lack, such as the ability to make additional deposits without accepting a lower interest rate. In addition, annuities offer an opportunity for deferring taxes that most investments do not. However, deferred annuities often charge much higher expenses to investors than do similar investments in the ETF and mutual fund universe, and after a while, some investors find that the benefits of deferred annuities don't outweigh these costs.
The problem that many annuity investors face is that getting rid of an annuity isn't as simple as just cashing in your account and taking your money back. Many annuities impose fees called surrender charges if you decide to sell within a certain period of time after your purchase. The time period for surrender charges can extend for as long as 10 years and can be substantial -- anywhere from 1% to 8% or more if you've held the annuity for only a short time. In addition, if you withdraw all of your money from your annuity, then the tax deferral that the annuity gave you immediately ends. You will therefore have to pay income tax on any profits you've earned, at ordinary income tax rates rather than lower capital gains rates that apply to many stocks and mutual funds. On the other hand, if you've lost money, you may be able to deduct your losses. To add insult to injury, if you're younger than 59 1/2, then you may owe a 10% early withdrawal penalty on top of any other charges that apply.
While many people don't consider life insurance to be a true investment vehicle, there are many forms of life insurance that include an investment component within policies. In general, simple term insurance, in which you pay an annual premium in exchange for a fixed payment to your heirs if you die, doesn't really constitute an investment. In contrast, other types of policies, including whole life, universal life, and variable life policies, accumulate value over time that is often only marginally related to the actual life insurance coverage that the insurance company provides.
For many investors, the primary purpose of life insurance is to protect their families from the financial consequences of unexpected accidents. As such, the need for life insurance tends to vary over time. When you're single and have no one who's financially dependent on you, then your need for life insurance is minimal or nonexistent. If you have young children to support, then your life insurance needs may be substantial while they're growing up. Later, as your children grow, you may need progressively less insurance to cover their childhood expenses. Although some people find new uses for life insurance, it's not uncommon for many to decide they no longer need any insurance at all.
With term insurance, if you no longer need your coverage, it's easy to cancel your policy. You stop paying premiums, and the insurance company no longer promises to pay benefits if you die. But other types of policies can raise complications. Although you'll usually receive the policy's cash surrender value, there can be tax implications depending on how much you've paid in premiums over the years. Furthermore, because these policies are designed to encourage long-term participation, you may find that your returns aren't as good as what your agent may have projected when you first purchased the policy. Some policies also impose early surrender charges that are similar to those charged for terminating annuity contracts.
Of course, even though you may not get all of the benefits you'd hoped to receive, that shouldn't stop you from cancelling insurance policies and annuity contracts that you no longer want or need. However, it's important to know what to expect before you take action, so you can make sure you get the best result. The second part of this article looks at how to dispose of other types of investments, including limited partnership interests and timeshares.
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Fool contributor Dan Caplinger isn't the world's best spring cleaner, but he does keep his investments in good order year-round. He doesn't own shares of the companies mentioned in this article. The Fool's disclosure policy is good for everyone.