Should An Annuity Ever Have A Place In Your Retirement Plan?

As you continue building your retirement income strategy, you’ve likely come across annuities. 

A neighbor may have recommended them, or maybe an insurance agent sent a letter advertising their offerings, or perhaps you saw a too-good-to-be-true ad on TV. So what exactly are annuities?

Annuities are financial products that can provide guaranteed income in retirement, but there’s more to them than meets the eye.

If you’re considering adding an annuity to your retirement plan, here are a few considerations to make first.

What Is an Annuity?

Simply, annuities are insurance products. 

Purchasing an annuity creates a contract between you and an insurance company. You agree to pay a specific amount to the company, and they guarantee a set amount back in return.

When purchasing an annuity, you can make a lump-sum payment to the insurance company or make payments over time. Similarly, you can either receive a lump sum payment from the insurance company or a series of regular payments. You can also choose to receive money immediately or later, depending on how your annuity is established.

The idea of an annuity is to provide retirees with a fixed stream of income. It’s an alluring offer—steady income in a world where turbulent markets, low-interest rates, and high inflation seem to be the mainstay. But annuities are complex vehicles with a significant amount of fine pint—let’s get reading. 

Types of Annuities

There are three common types of annuities for individuals to choose from:

• Fixed annuity
• Variable annuity
• Indexed annuity

Fixed Annuity

If you purchased a fixed annuity, the insurance company offers you a minimum rate of interest on the annuity and a predetermined amount of recurring payments. State insurance commissioners oversee and regulate fixed annuities.

Variable Annuity

There’s more flexibility in a variable annuity, as the company you purchase it from will allow you to direct your payments to different investment vehicles. The most common option is a mutual fund. 

Because there’s flexibility in where you invest your money, your payout, too, will vary. It will depend on how much money you put in, your rate of return on the investments, and any associated expenses. The SEC regulates this type of annuity.

Indexed Annuity

An indexed annuity acts almost like a hybrid between fixed and variable, meaning it combines common features of insurance products and securities. 

The idea is that the insurance company you purchase your annuity from will provide you payouts with a return based on the stock market index, like the S&P 500. In a fixed index annuity, you remain protected from market volatility while still benefiting from market upswings. 

Just like fixed annuities, state insurance commissioners regulate indexed annuities.

Pros of Annuities

People choose to purchase annuities primarily for these three reasons:

• Regular payments over time
• Death benefits
• Tax-deferred growth

Let’s take a closer look at each potential benefit.

Regular Payments Over Time

Perhaps the most consistent fear about retirement is running out of money.

It’s challenging to structure a retirement income and spending plan that will sustain you for the rest of your life, and a guaranteed income stream can be a great comfort in that department.

When you purchase an annuity, your provider establishes a set schedule of payments to be made over a specific period. Doing so creates long-term, stable income that helps bring peace of mind to individuals and couples during retirement. 

The payout period may be over the remaining lifetime of the annuity holder or even over the lifetime of their spouse, or other designated beneficiary, meaning that annuities could also be part of your estate plan. 

Death Benefits

Should you die before you begin receiving payments, your beneficiary will still be able to benefit from monthly payouts from your annuity.

Tax-Deferred Growth

Any growth due to returns earned from your annuity isn’t taxed until you begin receiving payments. This perk allows you to save money over time without paying taxes on the growth until you make withdrawals.

Cons of Annuities

While guaranteed income in retirement is appealing, there are some significant considerations to make before purchasing an annuity.

A few common concerns include:

• Fees and commissions
• Lack of liquidity
• Conservative returns

Fees and Commissions

Annuities come with a cost—often a high cost. 

And for some, the cost of added fees and commissions makes them a less-than-desirable retirement income option. You can expect different annuity types to come with different price tags. 

The more complex, the more expensive the product is likely to be. 

Lack of Liquidity

Once you’ve put your money into an annuitized contract, you’ve made a long-term commitment that can be very difficult and costly (if even possible) to get out of. 

For younger couples who have their peak earning years still ahead, it may not make financial sense to tie up so much of their money in this long-term financial product, especially if they have short-term goals like buying a home or paying for a child’s education.

Conservative Returns

Again, an annuity offers steady, guaranteed income. With that said, it’s a conservative investment option. This can make it appealing for those approaching retirement who don’t have time on their side to ride out potential market volatility. But for a younger couple, these more minimal returns would almost surely be an unnecessarily conservative option.

Legacy Wealth And Annuities

Financial advisors tend to have mixed reactions to annuities. 

Our Legacy Wealth advisors understand that they can be a good fit for some, but their cost is often a significant deterrent. We tend to see annuities oversold by other advisors, even when a better-suited option may be available for their clients.

If you’re considering purchasing an annuity, it’s a big financial decision that you shouldn’t take lightly. Our team would be happy to help you take a closer look at the benefits and considerations of annuities, just reach out to schedule a time to talk.