Demystifying annuities

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Cutting through BS and putting ordinary personal financial terms in clear terms.

Here’s a riddle: What is expensive, customizable and requires a lot of trust? Some answers include plastic surgery and your latest Etsy order, but the answer we’re looking for is today’s topic: annuities.

Annuities are contracts designed to provide income, either through a lump sum or through a stream of installments, and typically used in retirement to hedge the risk of longevity (which are afraid of living too long and your money running out ). They are also tax deferred, though this can get complicated.

You can buy an annuity through a seller or directly through an insurance company (the latter can save you on commission expenses). Your minimum investment depends on the type of annuity, but it can be as low as $ 2,500.

Your employer’s pension plans can start offering annuities as part of a target date fund thanks to the Secure Act. You can also consider buying one on your own. Let’s break down our riddle to understand annuities.

  • Expensive. You have mortality fees and expense risk to compensate the offering company for the longevity risk. Admin fees due to paperwork. The fund’s expense ratio in which your annuity can be invested. Commission to sellers. Withdraw fees if you withdraw from your contract. If you withdraw from your annuity before you reach the age of 59, you may be subject to a tax penalty of 10%. And on top of that, these costs may not even be worth it if you lose out on better returns on the market.
  • Can be customized. There are three main types of annuities: fixed, indexed and variable. You can also add riders to your contract to customize it to your liking – but they can mean higher fees.
  • Confidence. There are two phases of an annuity: the accumulation and disbursement phases. The company that offers your annuity matters because you need it to be part of the payout phase.Myriam

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