Annuities are among the most debated financial products in retirement planning. They can provide valuable guaranteed income in retirement — but they’re not right for everyone, and mistakes can be costly. Here’s what you need to know.
What Is an Annuity?
An annuity is a contract with an insurance company that provides regular payments in exchange for a lump sum or series of payments. In retirement planning, annuities are primarily used to create guaranteed income that you can’t outlive.
Do: Consider an Annuity If…
You Have an Income Gap
If your guaranteed income sources (Social Security, pension) don’t cover your essential expenses, an annuity can fill that gap with reliable, predictable income.
You’re Concerned About Longevity
If you’re healthy and have a family history of longevity, the risk of outliving your savings is real. An annuity provides income regardless of how long you live.
You Want to Reduce Market Anxiety
If market volatility keeps you up at night, having a portion of your retirement income guaranteed — regardless of what the market does — can provide significant peace of mind.
Don’t: Make These Common Mistakes
Don’t Put All Your Money in an Annuity
Liquidity matters in retirement. You need accessible funds for emergencies, healthcare costs, and changing needs. Only allocate a portion of your assets to an annuity — typically the amount needed to bridge your income gap.
Don’t Buy Without Understanding the Fees
Some annuities — particularly variable annuities — carry multiple layers of fees: mortality and expense charges, administrative fees, investment management fees, and rider charges. These can total 2-4% annually and significantly erode your returns.
Don’t Ignore the Surrender Period
Most annuities have surrender periods of 5-10 years during which you’ll pay a penalty for early withdrawal. Make sure you understand the liquidity constraints before committing.
Don’t Buy Based on a Sales Pitch
Annuities are sold, not bought. High commissions can create conflicts of interest. Always evaluate an annuity in the context of your complete financial plan — not as a standalone product.
Don’t Overlook Tax Implications
Annuity gains are taxed as ordinary income (not capital gains), which can be a disadvantage in some situations. The timing and structure of annuity income should be coordinated with your overall tax strategy.
Types of Annuities in Retirement
- Single Premium Immediate Annuity (SPIA): Trade a lump sum for immediate income. Simple, transparent, low cost.
- Deferred Income Annuity (DIA): Purchase now, income starts later (often at 80+). Relatively low cost for significant longevity protection.
- Fixed Indexed Annuity: Growth linked to a market index with a floor protecting against losses. More complex, higher fees.
- Variable Annuity: Investment options with insurance features. Highest fees, most complex.
The Right Approach
The question isn’t “Should I buy an annuity?” — it’s “Does an annuity solve a specific problem in my retirement plan?” The answer depends on:
- Your income gap (guaranteed income vs. essential expenses)
- Your other assets and income sources
- Your risk tolerance and peace-of-mind needs
- Your health and life expectancy
- Your liquidity requirements
- Your tax situation
At Financial Advisors AZ, we evaluate annuities as one tool among many in our income planning process — never as a default recommendation. If an annuity makes sense for your situation, we’ll explain exactly why and how it fits.
Contact us to discuss whether an annuity belongs in your retirement plan.
