Are Annuities Better Than Stocks? Breaking Down the Ultimate Retirement Showdown

When my clients are planning for retirement, they always ask me the same question: “Are annuities better than stocks?” It’s like trying to choose between chocolate and vanilla ice cream—each has its pros and cons, but in the end, your personal taste (and finances) will determine which is best.

As someone who’s spent years helping folks navigate the complex world of retirement planning, I can tell you there’s no one-size-fits-all answer. Let’s dive into this financial face-off and explore which option might be better suited for your golden years.

Understanding the Contenders: Annuities vs. Stocks

What Are Annuities?

Annuities are contracts between you and insurance companies where you make payments (either in a lump sum or over time), and in return, the insurer promises to pay you a stream of income, either immediately or at some point in the future

There are three main types of annuities:

• Fixed annuities guarantee your principal plus a minimum interest rate (currently can exceed 5% annually)
• Variable annuities are tied to the performance of underlying investments (similar to mutual funds)
• Indexed annuities link returns to a market index like the S&P 500, offering a middle ground between fixed and variable options

What Are Stocks?

Stocks represent ownership shares in companies. When you purchase stocks, you’re buying a piece of that business and potentially benefiting from its growth and profits through:

• Capital appreciation (increase in stock value)
• Dividend payments
• Long-term wealth accumulation

The Pros of Annuities: Safety First

Guaranteed Income

The biggest advantage of annuities—especially fixed annuities—is the guarantee. Just like your grandparents might’ve loved the predictability of pension plans, annuities provide that same sense of security.

“A life annuity provides guaranteed income for as long as you live, even after the insurer’s payouts have matched the amount of money you chipped in,” notes the Insurance Information Institute, which calls this type of annuity a “personal pension plan.”

Tax-Deferred Growth

With annuities, you don’t pay taxes on your earnings until you start receiving payments. This tax-deferred status means your money can grow faster over time—a huge plus if you’re in a higher tax bracket now but expect to be in a lower one during retirement.

No Contribution Limits

Unlike 401(k)s or IRAs that cap how much you can contribute annually, annuities have no limits. If you’ve maxed out other retirement accounts and still have money to invest, annuities provide an additional tax-advantaged option.

Optional Features (Riders)

Many annuities offer add-on features called riders that can provide inflation protection or guarantee that you won’t lose your initial investment, even if the market crashes. These customization options can be invaluable for tailoring your retirement strategy.

The Cons of Annuities: Limitations Abound

High Costs

Let’s be honest—annuities ain’t cheap! They typically come with various expenses, including:

• Administrative fees
• Investment management fees
• Surrender charges (if you withdraw early)
• Rider costs (if you add optional features)

All these fees can significantly reduce your returns compared to stocks.

Limited Liquidity

Ever tried to break a piggy bank that’s been super-glued shut? That’s kinda what accessing your annuity money early feels like. Most annuities charge substantial surrender fees (sometimes as high as 10%) if you withdraw funds within the first 6-10 years.

Plus, withdrawals before age 59½ typically incur a 10% tax penalty from the IRS. Ouch!

Complex Structures

Annuities can be confusing—there are immediate vs. deferred options, different payout structures, various fees, and numerous riders. Because they are so complicated, many people find it hard to fully understand them.

The Pros of Stocks: Growth Potential

Higher Return Potential

Historically, stocks have delivered impressive returns over the long haul. According to data from NYU’s Stern School of Business, $100 invested in S&P 500 stocks at the beginning of 1928 would have grown to nearly $625,000 by the end of 2022 (including dividends). That same $100 in Treasury bonds? Just over $7,000.

Liquidity

Unlike annuities, stocks can be sold quickly if you need cash. While market timing issues exist, there’s no surrender period or contractual limitations on accessing your money.

Tax Advantages

Stocks held in retirement accounts like IRAs or 401(k)s enjoy tax benefits. Even outside these accounts, long-term capital gains are typically taxed at lower rates than ordinary income (which is how annuity payments are taxed).

Step-Up in Basis

When stocks are inherited, beneficiaries receive a “stepped-up” cost basis to the market value at the time of death, potentially eliminating capital gains tax on appreciation that occurred during the original owner’s lifetime. Annuities don’t offer this benefit.

The Cons of Stocks: Risks and Volatility

Market Volatility

Stocks can be a wild ride! The S&P 500 jumped 28.7% in 2021 but plummeted 18.1% in 2022. This volatility can be nerve-wracking, especially as you approach or enter retirement when you have less time to recover from market downturns.

No Guarantees

Unlike annuities, stocks offer zero guarantees. Your investments could decrease significantly in value, potentially affecting your retirement lifestyle if the market tanks at the wrong time.

Requires Active Management

Managing a stock portfolio demands time, knowledge, and emotional discipline. Many retirees prefer not to worry about market fluctuations or investment decisions during retirement.

Who Should Choose Annuities?

Annuities might be better for you if:

• You prioritize guaranteed income above all else
• You’re uncomfortable with market risk and volatility
• You’ve already maxed out other retirement accounts
• You want protection against outliving your money
• You desire simplicity in your retirement income plan

One of my clients, Martha, was so stressed about market swings that she couldn’t sleep at night. Moving a portion of her portfolio to a fixed annuity gave her peace of mind, even though it meant potentially lower returns.

Who Should Choose Stocks?

Stocks might be better for you if:

• You seek maximum growth potential
• You have a long time horizon before retirement
• You’re comfortable with market volatility
• You want maximum flexibility and liquidity
• You’re concerned about keeping pace with inflation

On the other hand, my client Jack knows how markets work and keeps a long-term view. To get the most growth out of his retirement savings, he likes to keep most of them in a diversified stock portfolio.

The Best of Both Worlds: A Balanced Approach

The smartest strategy might be combining both annuities and stocks in your retirement portfolio. This approach, which I recommend to most of my clients, provides both security and growth potential.

Here’s how it might work:

1. Cover essential expenses with guaranteed income: Use Social Security, pensions, and annuities to ensure your basic needs (housing, food, healthcare) are covered regardless of market performance

2. Invest the rest of the money to grow it. Keep some in stocks and other investments to cover extra costs and fight inflation.

3. Adjust the mix as you age: Gradually shift from growth-focused investments to income-producing ones as you move through retirement

Real-World Example: The Bucket Strategy

One practical approach is the “bucket strategy,” where you divide your retirement savings into three categories:

This strategy allows you to benefit from stock market growth while ensuring you have stable income for immediate needs.

Key Factors to Consider When Deciding

When weighing annuities against stocks, consider:

• Your risk tolerance: How comfortable are you with market fluctuations?
• Income needs: Do you need predictable income or maximum growth?
• Time horizon: How many years until and during retirement?
• Other income sources: What guaranteed income (Social Security, pensions) do you already have?
• Legacy goals: How important is leaving money to heirs?
• Tax situation: How will different investment vehicles affect your tax liability?

My Bottom Line: It’s Not Either/Or

So, are annuities better than stocks? The answer is: it depends on your personal situation and goals.

For many retirees, the best strategy isn’t choosing one over the other but finding the right balance between them. I’ve seen the most successful retirees use annuities for financial security and stocks for growth potential.

Remember, retirement planning isn’t a competition between investment vehicles—it’s about creating a strategy that provides both financial security and peace of mind during your golden years.

Before making any decisions, consult with a financial advisor who can help you develop a personalized retirement plan based on your specific circumstances. What works for your golf buddy might not be the right fit for you!

Have you considered how annuities and stocks might work together in your retirement plan? What questions do you still have about these options? I’d love to hear your thoughts!