Annuities: The Pros and Cons of Adding One to Your Retirement Plan
by: Cory Carlton
When planning for retirement, one big question often pops up: How can I make sure I have enough money for my life in retirement? One option people consider is an annuity. They offer a way to get regular income during retirement and several other benefits, but they’re not for everyone. Here’s a straightforward look at the pros and cons of annuities to help you figure out if they’re a good fit for you.
So, What Exactly is an Annuity?
An annuity is a contract with an insurance company. You pay a lump sum or make payments over time, and in return, the insurance company gives you regular income—sometimes for the rest of your life. Different types of annuities can do different things. So give a guaranteed income that you can never outlive. Others focus on growing your money and others can give a guaranteed return every year no matter what.
Pros of Annuities
1. Lifetime Income, Guaranteed
One major draw of annuities is that they can provide a steady paycheck, even after you’ve stopped working. Some types even guarantee payments for life, which can offer peace of mind. Think of this like your own private pension that you can never outlive, only better. This is a 100% contractual guarantee.
2. Tax Deferred
Your money grows tax-free inside an annuity. You only pay taxes when you take money out, which can be helpful if you’re in a high tax bracket now and expect to be in a lower one later. Also, if you roll over money from your 401K to an annuity there are no tax consequences. You only pay taxes when you take your money out. If you understand how your 401K, 403B, or IRA are taxed, then you understand how annuities are taxed.
3. Some Offer Inflation Protection
Some annuities, like indexed annuities, let your money grow along with the market, which can help keep up with inflation. Others offer built-in adjustments to make sure your income stays useful as things get more expensive.
4. Customization Options
Many annuities let you add “riders” (think of these as add-ons) for things like spousal benefits or long-term care. Just keep in mind these extras can come with an added cost.
5. Stable and Predictable
Fixed annuities, in particular, offer a set rate of return, so they’re great for people who want a stable income and aren’t big fans of the ups and downs of the stock market. Here's a baseball metaphor for you: annuities are built to get on base. They are great at hitting singles and doubles. Every now and then they could hit a triple or a homerun but mainly they are built to get on base and never strike out (lose money due to performance).
6. Fees
People often look to lower fees as they get into retirement and an annuity can be a great option as many have no fees.
Cons of Annuities
1. Fees Can Be High
Wait, I just said in the lines above that they have no fees. That's true. Some annuities have no feels. Variable annuities (annuities with your money invested directly in the stock market) often have a lot of fees that can add up. There are charges for administration, risk, and any riders you add, which can eat into your returns over time.
2. Not Easy to Access Your Money
Annuities are long-term. Many come with surrender charges, which means you pay a fee if you want to pull out money early. This can be tough if you want quick access to your cash for an emergency. This is part of the reason you never put all your eggs in one basket. With surrender charges you always have access to 10% of your account value for free withdrawals. This generally is not an issue when you use an annuity as part of your overall plan and if your money is qualified. If your money is qualified you would never pull out too much otherwise it would create big tax issues.
3. They Feel Complicated
Annuities can be hard to understand, with lots of fine print and options that can feel overwhelming. Having a clear idea of what you’re getting is key, but it can be tricky without guidance. That's why we are here. We make these simple when they are appropriate for our clients.
4. Returns May Be Lower Than if You Invest Your Money With Us
While annuities are steady, that stability often comes at a cost of lower returns. You will likely see higher growth in the investments we help our clients with. If you need your money to grow as much as possible, we can help you invest it. If you want safety and predictability, an annuity may be more suitable.
5. Inflation Risk
If you opt for an income annuity, with a level income amount, there is a chance the guaranteed income amount you begin to receive will have less buying power as you get older due to inflation. Some annuities do have inflation riders to add to the income you receive.
These are some of the main pros and cons of considering an annuity for your retirement. Everyone's situation is different so everyone's plan will be customized. It's important to understand that you should not buy an annuity without knowing how it will be used in connection to your other retirement assets and income plan.
Need help with a custom retirement plan? That's what we do.