Retirees often seek a reliable source of income to cover their expenses and replace their paychecks. An annuity can be a vital financial product in this pursuit, offering guaranteed income and tax advantages. However, annuities come with their own set of advantages and potential drawbacks. Understanding these aspects is crucial in making an informed decision about whether an annuity aligns with your retirement goals and financial situation.

Advantages of Annuities

Annuities offer several benefits that make them appealing for retirement planning:

1. Regular Payments

Annuities provide contract holders with the opportunity to receive guaranteed monthly payments, offering a dependable source of income through retirement or as a bridge to Social Security in case of early retirement.^[1]

2. Potential Lifetime Income

Some types of annuities come with terms that guarantee payments for life. Structured to provide regular payments for the rest of one’s life, these annuities ensure that individuals do not outlive their savings, addressing the real concern of running out of money in old age.^[1] However, it may come at the cost of higher premiums than an annuity specified for a period of time.

3. Non-Market Options

Annuities are structured on payments over time, not based on equity value. So that leaves room for a wide variety of non-market as well as market-based payout structures that may provide a return based on interest rates, stock market performance, or a combination of both. This can be advantageous to someone who wants to combine some of the benefits of market returns with the stability of regular payments. It’s important to note that fixed and fixed index annuities do not participate in market indexes and is thus not an investment in the market or applicable index .^[2]

4. Guaranteed Rates of Return

Some annuity contracts, particularly fixed and indexed annuities, offer guaranteed rates of return, translating into a steady income stream.^[1]

5. Survivor Benefits

Some annuity contracts offer options for survivors, allowing beneficiaries to continue receiving payments upon the annuitant’s death, providing potential financial security for loved ones.^[1]

Potential Drawbacks of Annuities

While annuities offer various advantages, they also come with potential drawbacks to consider:

1. High Expenses and Commissions

Annuities often carry high fees and commissions, which can erode returns, especially in the case of variable annuities. The complexity of some contracts makes it challenging to fully understand internal expenses.^[1]

2. Difficult to Exit

Exiting an annuity contract may come at a significant cost, with insurers imposing high surrender charges, often amounting to 10% or more of the contract’s value. Surrender periods limit the ability to withdraw funds freely.^[1]

3. Potential for Value Loss

Variable and indexed annuities hold the risk of value loss due to poor investment performance. Early withdrawals can incur surrender charges, diminishing the value of the contract. Additionally, high fees and expenses can also impact annuity value over time.^[1] In addition, claims-paying ability is based on the issuing company’s solvency and financial standing, so if the issuing company fails, there’s no guarantee you’ll get your money back. Note that indexed annuities are not an investment in the market and therefore cannot have investment performance—they pay a return at the end of a period and its performance can follow, mimic, or be linked to market performance.

Conclusion

Retirees seeking a consistent income source to cover their expenses and replace their paychecks may find annuities to be a valuable option. Annuities offer the advantage of guaranteed income, tax-deferred growth, and survivor benefits, addressing longevity and financial security concerns in retirement. However, it’s essential to carefully weigh the potential drawbacks, including high expenses, surrender charges, and the possibility of value loss, to ensure that an annuity aligns with individual financial goals and risk tolerance. Consulting a financial advisor and conducting thorough research can provide clarity on whether an annuity is the right choice for your retirement income planning.