I just received a significant raise and now I can afford to save more. I already max out my 401(k) and a friend of mine said that the best thing to do now is to buy an annuity because that way I can get more tax-deferred growth. But my wife’s friend told her a whole life insurance policy would be better since there’s an insurance component. Last, a friend of mine at work says I shouldn’t do either; instead, he says, I should just get index funds. Who’s right?
–Jonathan P., 26, Cincinnati, OH
Congratulations on your raise, Jonathan. It appears that your increased income has made you attractive to a few others already.
Gary: Indeed, I scour the “Movers and Shakers” column every week. When’s the best time to catch you, JP?
While your dilemma may seem confusing, it’s actually not. Let’s address a few points:
While tax-deferred growth is important – especially for long-term saving objectives like retirement – it is far from the only consideration. You must also think about risk, required return, ability to access funds in an emergency, fees/penalties, and so forth. Both annuities and whole life insurance policies do promise the benefit of tax-deferred growth.
However, so does an IRA. With an IRA, you can invest in index funds, which will have very low expenses. So, if you are looking to save more for retirement and have not yet done an IRA, I’d start there. (You should also consider a Roth IRA, which allows the benefit of tax-free growth.)
An annuity is seldom an appropriate product for a 20-something because of the lack of flexibility in the product and the existence of other greater financial priorities typically not yet met by a 20-something (including full funding of 401(k), IRA, emergency fund, etc.). A whole life insurance policy is also not something relevant to a 20-something, especially one without any dependents. Life insurance is arguably the most important financial consideration out there – once you have a child (or, perhaps someone else) depending on your income. But if no one is hurt – financially speaking – by your untimely demise, you don’t need life insurance, and certainly not just to get the tax-deferred benefit.
But before you go ahead and put your money into an index fund, make sure you understand the goals for your money. If it’s for something long-term such as retirement, go ahead. But if you have not yet paid off all your high-interest debt, established an emergency fund, made significant progress towards a housing downpayment (or already own a home), I suggest starting in one of those places before putting more money in the stock market.
And be sure to continue to ask questions first, buying (perhaps) later. You’ll never regret sleeping on a financial decisions. If it’s a great idea today, it will still be a great idea tomorrow.