Who Benefits From an Annuity: Is This Retirement Option Right For You?

The Perfect Retirement Safety Net (For Some)

If there’s one thing I’ve learned from researching retirement options for years, it’s that a lot of people get annuities wrong. Some financial advisors try to sell them to everyone, while others act like they’re a fraud. The truth is that they’re not quite right for all retirees but just right for some.

Who can really benefit from an annuity? Let’s clear things up and see if you’re one of the people who should think about this retirement option.

What Exactly Is an Annuity?

I want to make sure we all understand what an annuity is before we talk about who gets one.

An annuity is a contract between you and an insurance company. You give them money (either all at once or over time), and in return, they promise to pay you income either immediately or at some point in the future The main appeal? That income can be guaranteed for life – something no other financial product can offer

As Brian Skrobonja, a Chartered Financial Consultant, puts it: “Annuities are the only product in the entire financial universe able to provide guaranteed income for a set period of time.”

There are three main participants in an annuity contract:

• The owner (that’s you) who purchases the annuity and pays the premiums
• The annuitant whose age and life expectancy determine the benefits
• The beneficiary who receives death benefits if the annuitant dies

Three Main Types of Annuities

Not all annuities are created equal. There are basically three types

1. Fixed annuities: These offer a guaranteed interest rate, similar to a CD but usually with higher rates.

2. Variable annuities: These let you invest in different types of stocks and bonds, like mutual funds. They have more growth potential but also more risk.

3. Fixed index annuities: These are a hybrid, offering some market-based returns without the risk of losing your principal.

Who Really Benefits From an Annuity?

Now for the big question – should YOU consider an annuity? Based on my research, these are the people who benefit most:

1. People Worried About Outliving Their Money

This is the #1 reason to consider an annuity. If you’re concerned about running out of money in retirement, an annuity with lifetime income benefits can eliminate that risk.

As one financial advisor explained to me, “When you purchase an annuity with lifetime income, you’re essentially buying a personal pension.” Even if you live to 110, those payments will keep coming.

2. Retirees Who Want Predictable Income

Do you want to know exactly how much money will be coming in each month? Many retirees find comfort in the certainty of fixed payments, especially for covering essential expenses like housing and healthcare.

3. Conservative Investors Who Hate Market Volatility

If market swings keep you up at night, certain types of annuities (particularly fixed or indexed annuities) can protect your principal while still offering some growth.

As Skrobonja explains: “If you are someone approaching retirement who wants to grow and protect your retirement income or simply wants to keep some of your money out of the market, protected from downside risk, then look into annuities.”

4. People With Limited Access to Traditional Pensions

Traditional pensions are becoming rare. If you don’t have one, an annuity can help fill that guaranteed income gap in your retirement plan.

5. Higher-Income Earners Looking for Tax-Deferred Growth

Annuities grow tax-deferred, meaning you don’t pay taxes on the earnings until you take withdrawals. If you’ve maxed out your 401(k) and IRA contributions, this can be an attractive feature.

Who Should Probably Avoid Annuities?

Annuities aren’t for everyone. Here are some folks who might want to look elsewhere:

1. Young Investors Far From Retirement

If retirement is decades away, the benefits of annuities (particularly the tax deferral) are outweighed by their restrictions and fees. You’re likely better off with more liquid investments.

2. People Who Need Liquidity

Most annuities have surrender periods (often 6-8 years) where you’ll pay penalties for withdrawing more than a certain amount (usually 10%). If you might need access to your money, annuities can be problematic.

3. Those With Sufficient Guaranteed Income Already

If your Social Security and pension already cover your essential expenses, you may not need the guaranteed income that annuities provide.

4. Fee-Conscious Investors

Some annuities (particularly variable ones) can have fees ranging from 2-3% annually. These can significantly impact your returns over time.

The Pros and Cons: A Balanced View

Let’s break down the advantages and disadvantages:

Pros of Annuities

• Guaranteed income that can last a lifetime
• Protection against market downturns (with fixed and indexed annuities)
• Tax-deferred growth until you start taking withdrawals
• No contribution limits unlike 401(k)s and IRAs
• Death benefits for your beneficiaries (with some contracts)

Cons of Annuities

• Surrender charges if you need your money early
• Fees and commissions can be higher than other investments
• Limited liquidity during surrender periods
• Complexity that can make them difficult to understand
• Tax penalties for withdrawals before age 59½

Common Myths About Annuities

There’s a lot of misinformation out there about annuities. Let’s address some common myths:

1. Myth: Annuities have lower growth potential
   Truth: Some annuities can grow just as competitively as a managed portfolio.

2. Myth: An income annuity will run out of money
   Truth: While an annuity account can deplete, the insurance component ensures income continues for life.

3. Myth: Annuities are too expensive
   Truth: Some annuities have high fees, but others have minimal or no fees at all.

4. Myth: The stock market performs well enough that annuities aren’t necessary
   Truth: Sequence of returns risk (getting bad returns early in retirement) can devastate a portfolio, while annuities protect against this.

Questions to Ask Yourself Before Buying an Annuity

If you’re considering an annuity, ask yourself:

• How much guaranteed income do I need beyond Social Security and pensions?
• How long can I leave money in the annuity?
• When will I need income payments to begin?
• Does the annuity allow me to access money when needed?
• Am I comfortable with the fees and surrender charges?

Tips for Smart Annuity Shopping

If you decide an annuity might be right for you:

1. Don’t buy the first one you’re offered. Shop around and compare.
2. Understand all fees and charges. Ask specific questions about surrender charges, annual fees, and rider costs.
3. Verify the insurance company’s financial strength. Check ratings from agencies like A.M. Best or Standard & Poor’s.
4. Consider working with a fiduciary. They’re legally obligated to act in your best interest.
5. Take advantage of the free look period. Most states give you 10-30 days to cancel a new annuity contract without penalty.

The Bottom Line: Are You a Good Candidate?

An annuity isn’t inherently good or bad – it’s just a tool that works well for certain situations. You might benefit from an annuity if you:

• Want guaranteed income for life
• Are concerned about market volatility affecting your retirement
• Have maxed out other tax-advantaged retirement accounts
• Want to protect a portion of your retirement savings from market risk

As Wisconsin’s Best Interest law highlights, insurance companies and agents must exercise reasonable diligence to determine whether an annuity is in your best interest before making a recommendation.

Remember, annuities are complex financial products. Don’t rush the decision, and consider consulting with a financial advisor who can help evaluate whether an annuity makes sense for your specific situation.

In my opinion, the ideal approach is usually to dedicate only a portion of your retirement savings to annuities – enough to cover your essential expenses when combined with Social Security and any pension income. This gives you the security of guaranteed income while maintaining flexibility with your remaining investments.

Have you considered an annuity for your retirement? What questions do you still have about them? I’d love to hear your thoughts in the comments!