What to Know Before Choosing an Annuity for Retirement
Annuities are often promoted as reliable retirement income solutions, but their complexity, variety, and long-term commitment mean careful consideration is essential. This guide explores immediate, deferred, and indexed annuities. It lays out their pros and cons to help you decide whether these financial tools fit your retirement strategy and goals.
Why Some Retirees Use Annuities to Secure Income
In retirement, income typically shifts from steady employment earnings to withdrawals from savings and investments. These withdrawals can be influenced by market conditions and timing. Some retirees include annuities as part of their overall strategy to help manage income needs and reduce exposure to market fluctuations. Whether an annuity is appropriate depends on individual goals, risk tolerance, and financial circumstances.
The reason some people choose annuities
The reason some retirees choose annuities is the retirees choose annuities is the assurance of a steady income stream. Certain types, such as immediate and lifetime annuities, can provide monthly payments for as long as you live, helping cover essential expenses.
- Income Options Designed for Lifetime Payouts
One reason some retirees consider annuities is their ability to provide a predictable income stream. Certain types of annuities, such as immediate or lifetime annuities, can offer regular payments for as long as the annuitant lives. Payment amounts and terms depend on the contract and the issuing insurance company’s guarantees. - Managing Market Risk
Unlike investments that fluctuate with market performance, some annuities may include features designed to help stabilize returns or preserve principal. These guarantees are subject to the claims-paying ability of the issuing insurance company and do not apply to the underlying investments of variable annuities. - Customizable Benefits
Many annuities allow the addition of riders—optional features that can further protect income, guarantee payouts for spouses, or provide enhanced benefits for long-term care or inflation.
- No Required Distributions
Unlike IRAs, most non-qualified annuities aren’t subject to required minimum distributions, allowing for more control over withdrawals and taxes.
However, it’s important to remember that annuities are not for everyone. They typically require a long-term commitment and sometimes come with higher fees and limited liquidity. Understanding the different types is crucial before making any decisions.
How to Compare Annuity Options Based on Your Retirement Plan
Not all annuities are the same. Each type offers distinct features, potential benefits, and limitations. Matching an annuity to your plan depends on personal goals, time horizon, and income needs. The following overview is for informational purposes only and not a recommendation.
Immediate Annuities (Income Now)
What are they?
You pay a lump sum up front and begin receiving payments soon after—typically for life or a set period.
Potential Benefits:
- Provides predictable income payments
- Helps support budgeting for essential expenses
- May reduce exposure to short-term market volatility
Considerations:
- Limited access to principal once payments begin
- Payments may not keep pace with inflation
- Limited flexibility if spending needs change
Who might consider:
May be appropriate for individuals who want to convert a portion of savings into a predictable income stream for basic living expenses.
Deferred Annuities (Income Later)
What are they?
You invest funds now, with income starting at a future date. Deferred annuities may be fixed, variable, or indexed.
Potential Benefits:
- Tax-deferred growth
- Flexibility to choose when income begins
- Potential for higher payments due to longer accumulation periods
Considerations:
- May include administrative or rider fees
- Early withdrawals may be subject to penalties or surrender charges
- Investment risk varies depending on the annuity type
Who might consider:
May suit individuals planning ahead for future retirement income needs.
Indexed Annuities
What are they?
Indexed annuities link returns to a market index (e.g., S&P 500®) but typically include a cap or participation rate on gains.
Potential Benefits:
- Opportunity for limited market participation with downside protection
- May include principal protection and optional income riders
Considerations:
- Returns are capped and may not match market performance
- Contract terms can be complex
- Withdrawals may be subject to surrender charges or limits
Who might consider:
May appeal to investors seeking some market exposure with more predictable outcomes than direct equity investing.
Evaluating Fees and Surrender Charges
Annuities may include mortality and expense charges, administrative fees, rider costs, and surrender penalties for early withdrawals. These costs can affect overall returns. Review fee disclosures carefully and make sure you understand all costs before purchasing.
Matching Payout Options to Your Needs
Common payout structures include lifetime income, joint-life income, or fixed-period payouts. Selecting an option should reflect your health, life expectancy, family circumstances, and financial goals.
Understanding Tax Implications
With non-qualified annuities, only the earnings portion of a withdrawal is taxable as ordinary income. For qualified annuities (funded with pre-tax dollars), all withdrawals are generally taxable. Withdrawals before age 59½ may be subject to an additional 10% IRS penalty.
Inflation and Income Riders
Fixed payments may lose purchasing power over time. Some annuities offer optional riders or inflation adjustments, often at an additional cost. Review these features carefully to determine whether they align with your long-term expectations.
Liquidity Needs
Many annuities limit access to principal, especially in the early years. If you anticipate needing funds for unexpected expenses, review the contract’s surrender terms and any available free-withdrawal provisions.
Working with a Financial Professional
Because annuities can be complex, working with an experienced financial professional can help you assess whether an annuity fits within your broader retirement plan.
Professional Guidance
A fiduciary adviser can help evaluate options, explain contract details, and align annuity features with your income goals, risk tolerance, and family needs.
Comprehensive Planning
A professional can also help coordinate annuities with other income sources, such as IRAs, pensions, and Social Security.
Transparency and Due Diligence
Your adviser should explain all product features, fees, and tax implications, and provide personalized illustrations to support informed decision-making.
Ongoing Support
An effective advisor relationship doesn’t end after you purchase an annuity. Regular reviews can help determine whether your annuity and overall retirement strategy continue to align with your evolving goals, market conditions, and regulatory changes. At Retire SMART, we conduct scheduled annual reviews with clients and maintain ongoing communication throughout the year to help ensure portfolios remain appropriately structured and clearly understood.
Conclusion
Annuities can play a valuable role in a comprehensive retirement plan when chosen and managed carefully. Because each product and individual situation is different, it’s important to review all available options, understand the associated costs and risks, and work with a qualified financial professional who can provide objective guidance tailored to your needs. Taking a proactive, informed approach can help you maintain financial confidence throughout retirement.
Disclosure – Annuity guarantees are subject to the claims-paying ability of the issuing insurance company. Features, benefits, and limitations vary by contract and carrier. This information is provided for educational purposes and should not be construed as a recommendation or individualized advice. Clients should consult a qualified financial or tax professional before making investment or insurance decisions.
