5 Reasons Why You May Want to Buy an Annuity

Annuities are often used to create steady income in retirement by providing regular payments for a set period or for life. They can add security by offering predictable income that is not directly tied to market performance. At the same time, annuities have specific structures, costs and trade-offs that should be carefully reviewed before deciding if they fit into your retirement plan.

Thinking of incorporating an annuity into your retirement plan? Consider working with a financial advisor.

Annuity Basics

An annuity is a financial product providing a stream of income in exchange for a lump sum payment or series of payments. Annuities are typically offered by insurance companies and are designed to help individuals manage retirement income by providing regular payments over time.

These products come in various forms, including fixed, variable and indexed annuities. Each has its own unique benefits and risks.

Fixed annuities offer guaranteed payments at a set interest rate, making them a conservative choice for retirees seeking stability.
Variable annuities fluctuate with market performance, offering the potential for higher returns but also higher risks.
Indexed annuities are tied to an index like the S&P 500, providing some growth potential with protections against severe market downturns.

Most annuities have two phases:

The accumulation period, during which money is invested and grows tax-deferred.
The distribution phase, when annuity payments to the annuitant begin.

Annuities can be structured to pay out for a set number of years or for the annuitant’s lifetime, offering flexibility to meet different financial needs and goals.

5 Reasons Why You May Want to Buy an Annuity

Annuities provide features such as guaranteed income and tax advantages that can make them a useful tool for retirement planning.

Annuities offer several benefits that make them an attractive option for those looking to enhance their retirement planning.

1. Guaranteed Income for Life

One of the primary advantages of annuities is the guarantee of lifetime income, which provides consistent cash flow regardless of how long you live. This steady stream of payments can help cover essential expenses such as housing, healthcare and daily living costs, reducing the uncertainty that comes with relying solely on investments or personal savings. For retirees who are worried about outliving their assets, a lifetime annuity can add a layer of financial security and stability to their overall retirement plan.

2. Tax-Deferred Growth

Annuities allow investments to grow tax-deferred, so you do not pay taxes on earnings until you start receiving payments. This feature can benefit individuals in higher tax brackets during their working years, as it postpones taxes and lets the investment grow without annual deductions. Once withdrawals begin, payments are taxed as ordinary income, which may result in tax savings if your income and tax bracket are lower in retirement.

3. Protection from Market Volatility

Fixed and indexed annuities can appeal to conservative investors because they provide protection from market volatility and guarantee a steady stream of income. Unlike stocks or bonds that fluctuate with market conditions, fixed payments from these annuities remain stable, which can help preserve retirement income during downturns. Indexed annuities also allow for some growth potential by linking returns to a market index, while still limiting downside risk. For risk-averse investors, these features make annuities a tool for maintaining financial stability in retirement.

4. Flexible Payment Options

Annuities can be tailored to fit individual needs, with options for payments over a fixed period, for a lifetime or for distributions to beneficiaries after the annuitant’s death. This flexibility allows retirees to create a financial plan that aligns with their income needs, lifestyle and legacy goals.

5. Long-Term Care and Legacy Benefits

Some annuities offer optional riders that help cover long-term care costs, such as assisted living or nursing home expenses. They may also include a death benefit so that any remaining balance goes to your beneficiaries. These features make annuities more than just a source of income, as they can also support healthcare needs and provide estate planning benefits.

Annuity Drawbacks and Considerations

While annuities offer distinct benefits, there are important drawbacks to consider before committing to an annuity. Here are six general things you may want to consider:

Inflation risk: Fixed payments from annuities may lose purchasing power over time as the cost of living increases. Unless you purchase an inflation rider—which typically comes at an additional cost—your income stream may not keep up with rising expenses. This erosion of value can make it harder to maintain your standard of living during a long retirement.
Fees and charges: Annuity fees are often high and can include administrative charges, mortality and expense risk fees and investment management fees. These can reduce the net return on your investment.
Surrender charges: Most annuities impose a surrender charge if you withdraw funds within a certain period, typically in the first seven to 10 years. These charges can be significant, especially if you need to access your funds early.
Limited liquidity: Annuities are generally less liquid than other investments, making it difficult to access your money in an emergency without incurring penalties.
Complexity: Variable and indexed annuities, in particular, can be complex and difficult to understand. It is essential to thoroughly understand the terms, fees and potential risks before purchasing.
Tax implications: While annuities grow tax-deferred, withdrawals are taxed as ordinary income rather than capital gains, which may result in a higher tax liability for some investors.

Bottom Line

Annuities offer guaranteed income and tax-deferred growth but come with fees, limits on access and work best for long-term investors with stable savings.

Annuities can be useful in retirement by offering guaranteed income, tax-deferred growth and some protection from market volatility, which may help balance other investments. At the same time, they often involve fees, surrender charges and limited access to funds, making them less flexible than other options. For this reason, annuities tend to work best for individuals who already have sufficient savings, do not need immediate liquidity and are prepared to keep the contract in place for the long term.

Frequently Asked Questions

Is an Annuity a Good Investment for Retirement?

Annuities can be a good choice for retirement if you need stable income, tax-deferred growth or protection against market volatility. However, they may not be suitable for those seeking liquidity or higher growth potential.

What Are the Fees Associated with Annuities?

Fees vary by annuity type and provider, but common fees include administrative costs, mortality and expense risk charges, investment management fees and surrender charges for early withdrawals. Fees vary by annuity type and provider.

Can I Withdraw from an Annuity Early?

Yes, but early withdrawals often incur surrender charges, especially if made within the initial contract period. It is best to review the contract terms to understand the penalties and fees associated with early access.

Tips for Retirement Planning

Managing investments can be challenging and a financial advisor can help strengthen your retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
You may also want to use a retirement calculator to help you gauge how much you might need to live the retirement you want.