Annuities promise retirement income with guaranteed returns and no risk to capital, but do they deliver? 

An annuity is a contract between an insurance company and an individual. You pay into the annuity over time or in a lump sum, and they provide a steady stream of retirement income.

Annuity Advantages

When you retire, the paychecks stop coming in. One of the biggest advantages of an annuity is guaranteed income. An annuity provides regular, predictable income, just like a paycheck.

Another advantage is the hands-off approach. You don’t have to watch the stock market or concern yourself with calculating distributions or rebalancing your portfolio.

Annuity Disadvantages

Naturally, all that convenience comes at a cost. Annuities have high commissions and fees. Also, if you change your mind and decide to pull your money out, you might have to pay a sizeable surrender fee. 

EGGSTACK RETIREMENT PLANNER

Another concern is the stability of the insurance company that issues the annuity. If they go out of business, you could be left holding the bag. You need to choose a well-known, reputable insurance company.

Is an Annuity Right for Me?

An annuity is the perfect solution for some people, while not being the best choice for others. It all depends on the type of person and how much money is involved. 

Right for an Annuity

• Someone who is unfamiliar with financial matters, investing, and retirement planning.
• Someone who has the means and willingness to pay for convenience.
• Someone who may be prone to anxiety and worry.

Wrong for an Annuity

• Someone who is knowledgeable about investing and planning.
• Someone who wants to get the most for their money.

Annuity Psychology

As regular readers know, I drive a 10-year-old Toyota with 150,000 miles on the odometer. It’s super-cheap to operate and it provides the most bang for the buck in terms of basic transportation. It’s also kind of scary on the highway. It feels like you’re being kicked down the road in a tin can.

One time when I had to travel for business, the company I work for set me up with a Ford Expedition. It was an enormous vehicle by my standards, and the ride was so smooth it was almost as if it was driving itself. Obviously, it’s not the most efficient way to travel. You’re blowing dollar bills out the tailpipe all day long.

If I may draw an analogy between these two vehicles and the decision to get an annuity, the Ford Expedition is the annuity, and the Toyota is do-it-yourself retirement planning. 

You might be reading this article for yourself, or you may be assisting a family member. If it’s the latter, let’s cut to the chase: if “Right for an Annuity" describes your loved one, get the annuity. 

Someone who knows little about finance and is prone to worry is going to experience a mini-meltdown every time a distribution is needed or a portfolio adjustment becomes necessary. You will save everyone involved a lot of unnecessary stress by putting their retirement savings into an annuity.

Types of Annuities

There are three main types of annuities:

• Fixed Annuities which pay a guaranteed return similar to a CD or a bond.
• Indexed Annuities which promise some portion of growth from the stock market while shielding your principal from loss.
• Variable Annuities which contain mutual funds invested in stocks, bonds, real estate, and commodities such as precious metals and energy. Unlike the other two types of annuities, your principal is at risk with a variable annuity.

Annuities can be further categorized based on timing:

• Immediate Annuities: Pay out from the start.
• Deferred Annuities: Pay out at a later date such as when you retire.

Funding Annuities

An upfront investment is typically needed to initiate an annuity. After that, deferred annuities are funded by ongoing premium payments.

A single premium annuity is funded by one large payment. Single premium annuities are often the result of a rollover. Annuities can be purchased either inside or outside of a qualified plan such as an IRA or 401(k).

Annuity Distributions

There are several options available for annuity distributions:

• Straight Life: The annuity will pay out for the rest of your life even if the total payout exceeds the amount paid into the annuity plus accumulated growth. Payments cease upon the annuity owner’s death, even if the total payout is less than the amount paid in plus accumulated growth.
• Life with Period Certain: The annuity will pay out for life but not less than a specified number of years, typically 20. The Life with Period Certain option is designed to prevent the Straight Life scenario from playing out where an annuity owner dies before the amount invested has been fully distributed.
• Joint Life: Same as Straight Life but with two owners, typically a married couple. The Joint Life option continues to pay out as long as one of the owners is living.
• Joint Life with Period Certain: Same as Life with Period Certain but with two owners. The Joint Life with Period Certain option continues to pay out as long as one of the owners is living, and not less than a specified number of years.

Annuities and Taxes

Annuities enjoy tax-advantaged status. If the annuity was funded with pre-tax dollars such as a rollover from a qualified plan, all of the distributions will be taxable. If the annuity was funded with after-tax dollars, only the investment returns are taxable. The taxable portion of annuity distributions are taxed as ordinary income.

The History of Annuities

Annuities have existed in one form or another since the Roman Empire. People paid a lump sum to the Roman government in return for annual payments for the rest of their lives.

Annuities first came to America in the 18th century as a means to support church ministries. Fixed annuities grew in popularity and became a mainstay of conservative investors. Although the first variable annuity was created in 1952, they did not become popular until the 80s. Those were followed by indexed annuities in the 90s.

Final word

An annuity provides a specific amount of money at a set frequency no matter what the stock market is doing. Annuities provide certainty in an uncertain world. They insulate investors from economic downturns and market crashes.

Conservative investors are drawn to fixed annuities, while younger and less risk-adverse investors may appreciate the growth potential of variable annuities.

Annuities provide a steady source of income when your working years are over. They offer many benefits and provide a secure retirement for millions of Americans.

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