Annuities are one of the most talked-about and misunderstood financial products in retirement planning. For some retirees, they offer peace of mind by providing a guaranteed stream of income. For others, they raise concerns about cost, complexity, or lack of flexibility.
The truth is that annuities can serve a valuable role for certain retirees, but they are rarely a complete solution by themselves. In this article, we will explore the pros and cons of annuities and discuss when they may make sense as part of a broader retirement income strategy.
What Is an Annuity?
An annuity is a contract between you and an insurance company. In exchange for a lump-sum payment or series of payments, the insurance company promises to provide income in the future. That income may be paid for a set number of years or for life, depending on the type of annuity.
There are many types of annuities, but most fall into three categories:
- Immediate annuities: Begin paying income right away.
- Deferred annuities: Income starts at a future date.
- Fixed, variable, or indexed annuities: Offer different ways to grow the value of your annuity before payouts begin.
The other main point of confusion is how money is taken out
Pros of Annuities
1. Guaranteed Income
For retirees who want the security of knowing a portion of their income is guaranteed, annuities can provide peace of mind. The guarantee is backed by the financial strength of the insurance company.
2. Longevity Protection
Annuities can help protect against outliving your money. Lifetime income options pay for as long as you live, which can complement other sources of income like Social Security.
3. Tax Deferral
Earnings within an annuity grow tax deferred until withdrawals are made. This may appeal to investors looking to delay taxes on a portion of their retirement savings.
4. Customizable Features
Many annuities offer optional features, such as inflation adjustments or death benefits, which can be tailored to your needs. However, these features typically come at an added cost.
Cons of Annuities
1. Complexity
Annuities can be difficult to understand. Riders, payout options, rate of return calculation, fees, and surrender charges vary widely between products. It is important to carefully review any contract and understand what you are buying.
2. Costs and Fees
Many annuities have high fees compared to other investment options. It is important to understand these costs and how they may impact the benefits being promoted. It is common for the annuity provider to be able to change the costs while you are still in the “surrender period.”
3. Lack of Liquidity
Many annuities have surrender periods, during which withdrawals beyond a set amount may incur penalties. This can limit flexibility in accessing your money.
4. Inflation Risk
Fixed annuity payments may lose purchasing power over time if not properly indexed to inflation.
How Can You Access Money From an Annuity?
Annuities offer several options for withdrawing money, and it is important to understand the pros and cons of each. Some investors choose to “annuitize,” which means converting the value of the annuity into guaranteed payments for life or for a set period of time. Annuitizing typically provides the most guaranteed income initially but provides the least flexibility and no growth potential unless you choose an option with a cost-of-living adjustment. Others may choose an annuity with an income rider. This route offers more flexibility and the potential for continued growth but generally provides less guaranteed income initially. Many deferred annuities also allow for free withdrawals of a certain percentage each year, typically around 10 percent, without triggering surrender charges. Or you can access all of the funds once you have waited out the surrender period.
Where Annuities Fit in a Retirement Plan
Annuities are not a “one size fits all” solution. However, they can complement other parts of a retirement income plan for those seeking:
- Guaranteed income to supplement social security.
- Protection against longevity risk.
- Peace of mind in volatile markets.
At Morrison Wealth Advisors, we believe that for retirees who value guarantees, an annuity can serve as one part of a diversified income strategy. It should not replace a comprehensive plan that includes:
- Investments for growth and flexibility.
- Tax planning.
- Estate and legacy considerations.
- Planning for health care and long-term care.
The key is to use annuities thoughtfully, balancing guarantees with the need for flexibility and growth.
Conclusion
Annuities can provide valuable guarantees for retirees who want stability and lifetime income. However, they are not without tradeoffs. Costs, complexity, and loss of flexibility need to be weighed carefully.
As part of a well-rounded retirement plan, annuities may help certain retirees sleep better at night — but they should never be the entire solution.
If you are curious about whether an annuity fits your retirement strategy, we invite you to schedule a consultation. We can help you evaluate all your options and design a plan that aligns with your goals and values.
