Retirement researchers are often excited about annuities, but many consumers are appropriately doubted. Here Christine Benz is the director of the Morningstar’s Personal Finance and Retirement Plan to discuss the basic information about the annuity and their professionals and opposition.
This interview is edited for length and clarity.
Question: How do income annuals work, and they are different from investing in something that pays income like bonds?
A: An annuity is a contract with an insurance company. The most basic annuity type, in income annuals, you give a pool of your money to the insurance company, and they send it back as a stream of income in your lifetime. Those types of products can earn you by investing in a bond.
They do this because you benefit in annuity, which is called “longevity risk pooling”, which means that some people who are buying the same annuity will soon die, which increases payment for your entire group. If you are the one who is 99 years old, then you are the winner in that situation. This is one of the reasons that the payments are more than you for traditional fixed-oriented devices. The second big reason is that if you buy an annuity, your money has gone effectively. You get cash flow, but you cannot take your principal back. Conversely, when you buy a bond, you get income, but you finally get your principal back.
Question: How can these types of annuals help with retirement plan?
A: These very basic income annuities can be helpful in addressing the basic living expenses of a home. Say my domestic basic expenses – Housing, tax, healthcare -total $ 40,000, and social security is going to give me another $ 30,000 of that $ 40,000. I could buy an annuity that would supply me $ 10,000 per year to help me meet those basic cash flow needs. This is an elegant use of an annuity, and it can help retired people find out how much they want to put in such a product, checking how much they really need it.
Question: Savings annuals, or “postponed annuities”, allow investors to achieve market risk in addition to income. What are some major savings annuities types?
A: The most familiar is a variable annuity where you are under control of investment allocation. There are also rapidly popular “fixed index” annuities, where you get market exposure, but have cap on your profit. There are also caps on your loss. The registered index-linked annuity falls between those two product types on the risk spectrum.
Question: These products are more complex than income annuals, and they carry a higher risk and high cost. How can investors ensure that they know what they are doing with these products?
A: Usually, these products carry long contracts with a lot of fine prints. This can be very difficult for consumers. You can hire an objective third party to help understand what you are doing.
At least, write all your questions. There are no silly questions in this context, because there is no transparency for consumers. Ask about cost, withdrawal, and what you are getting with this product that you can’t find with a very vanilla investment portfolio that will give you more liquidity and more access to your funds. Do not sign the line below until you end all those questions. You also want to ask about the financial strength of the insurance company supporting the annuity, as it is a long -term relationship. You need to make sure that whatever promises they are making, they are able to do well on it.
Question: What are the tax implications of annuity?
A: It depends on the account you use to fund the annuity, but usually, you will pay taxes. As long as there is money in the annuity of wealth, you get some tax distall, and then you will pay taxes on any money, which has not been taxed yet. If you put pretax dollars in annuity and this investment gives benefits, then all your withdrawal will be taxable at your simple income tax rate.
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This article was provided to the Associated Press MorningstarFor more individual finance materials, go to https://www.morningstar.com/personal-finance
Christine is the director of Benz Morningstar’s Personal Finance and Retirement Plan.
Related links:
1. The readiness of a retirement checklistthtps: //www.morningstar.com/personal-finance/retyment-krediness-checklist