The Pros and Cons of Annuities: How to Evaluate Annuities for Your Retirement

If you are worried about paying for retirement, it is worth evaluating the pros and cons of annuities.

pros and cons of annuities
The Big Takeaways…


  • Annuities are a great way to provide guaranteed lifetime income in retirement while hedging against inflation and other financial woes.
  • Though less risky, annuities generally yield lower returns than other investment products, and often come with high fees, so it’s important to do your research before buying.
  • You can quickly figure out if an annuity is right for your retirement plan with the NewRetirement Planner, or estimate how much income your retirement savings can generate using our Annuity Calculator.

An annuity is an insurance product that pays out income. You make an investment in the annuity and then it makes payments to you, giving you a dependable income stream during retirement.

The Pros of Annuities

Annuities offer some considerable benefits over other kinds of retirement investments, especially for those not able or willing to risk losing a portion of their retirement savings to stock or bond market swings.

The pros of annuities include:

  • Lifetime Income – With an immediate lifetime annuity contract, you are guaranteed periodic payments for as long as you live. The “risk” of you living a long and happy life is carried by the insurance company providing the annuity.

Social Security and pensions offer a similar form of retirement income protection but in limited dollar amounts. The only limit to the size of your periodic annuity payment is the amount of money you have to purchase an annuity now. Even better for many retirees, the older you are, the larger your monthly payments will be for the same price.

  • Inflation Protection – You can customize annuities to ensure that your monthly paycheck will keep pace with the cost of living. This is critically important because inflation can have a devastating effect on your assets. The downside of an add-on like inflation protection is that it will cost more – either in initial costs or in lower payouts when you begin to collect.
  • Principal Protection – One of the best features of fixed- and equity-indexed annuities is that the value of the annuity can be guaranteed to be at or above the amount invested. You can guarantee that you (or your heirs) will receive back at least as much money as you invested in the annuity.
  • Tax Efficiency – The purchase of an annuity with qualified retirement savings (401k or IRA funds) can save you money on taxes over taking a lump sum payment. You can rollover qualified funds into a qualified annuity without any tax penalties. You only pay taxes on the income the annuity provides.
  • Predictability: Having predictable retirement income (presumably adequate income to cover all of your expenses) can help you feel happier.  Lifetime annuities provide that kind of predictability.  Conversely,  retirees who must withdraw money from investments to pay for retirement expenses experience greater financial anxiety.

In sum, an annuity is a great way to protect your quality of life in retirement. Your retirement assets can be efficiently used to purchase guaranteed income to last as long as you need it. Best of all, this income can be protected from inflation and other financial risks.

So, What are the Cons of Annuities?

Despite the many advantages of annuities, they do have some downsides.

  • Not All Annuities Are Created Equal – The financial planning community views some annuities — particularly fixed annuities — as being a good solution to most retirees’ need for guaranteed income. However, other annuity products do not have a great reputation. Some advisors see them as an unnecessary and expensive product. It is very important that you understand the various features and terms that are applied to annuities.
  • Lower Returns on Your Investment – In return for the retirement income certainty provided by fixed annuities or equity-indexed annuities, you forgo the opportunity to make bigger returns by investing your money in assets that fluctuate in value, like stocks. A fixed annuity is considered to be a safe and conservative investment but this means that you will not see the possible gains (and losses) of a riskier investment.
  • High Costs: Sales commissions and management fees are a common complaint about annuities.  And, sometimes costs are definitely too high.  When purchasing an annuity, it is recommended that you shop around and really know exactly what you are paying for.
  • Inflexible – Annuities are also typically less flexible than other retirement options. Once you purchase an annuity contract your capital is tied up in the annuity, so you don’t have access to that lump of money.

Some retirement financial planners recommend that people reserve at least 40 percent of their retirement assets for unforeseen circumstances. Because most annuities are designed to provide steady income over time, they are not ideally suited to cover large unplanned expenses.

(However, although undesirable, if circumstances require it, there are third-party companies that will exchange a lump sum payment for your fixed-income payments. In this situation you will likely end up receiving less than the amount you paid for the annuity.)

What Are the Annuity Benefits for YOU and YOUR Retirement?

So, what do you think about the pros and cons of annuities for your retirement?  Use an annuity calculator to estimate exactly how much income you can buy. Or, better yet, see how an annuity fits into your overall retirement plan by using the NewRetirement Retirement Planning Calculator.

This detailed tool will let you model an annuity in the context of your overall retirement finances. You can even try all kinds of different scenarios. What happens if you:

  • Buy the annuity now or 10 years from now?
  • Start receiving the annuity this month or in 15 years?
  • Include a cost of living adjustment or not

Annuity Frequently Asked Questions

Though the basic concept of an annuity is pretty simple — you’re buying a stream of income — the many, many varieties of annuities can make figuring out which annuity product is right for you difficult. Here is a list of FAQs most people ask when shopping for an annuity.

What Do the Ratings for Annuity Providers Indicate?

Ratings indicate the relative financial strength of insurance companies. The two largest rating agencies, A.M. Best and Standard & Poor’s, use their own individual criteria to grade insurance providers. Because the federal government does not guarantee annuity products, prospective buyers should use these ratings to gauge risk.

How Much Income Can I Receive Every Month With an Annuity?

The amount you will receive every month depends on a number of factors: your age, gender, state of residence, how much money you invest in the annuity, and what different insurance companies are quoting for their particular annuity products. (Different annuity insurance companies will quote different prices for the same product with the same features. It is important to compare annuity companies.)

Other factors that will determine how much income you receive include the type of annuity you specify (fixed annuity, variable annuity, tax-deferred annuity, indexed annuity, guaranteed variable annuity, etc…) and the features you apply to that annuity (asset protection, guaranteed principal protection, etc.)

You can use our Annuity Calculator to estimate the amount of money you will likely be able to receive from an annuity for a given set of criteria and investment amount.

Can I Alter the Amount of My Cash for Annuity Payments After Purchase?

Once you’ve purchased your annuity, it’s generally not possible to alter or accelerate payments. You can purchase more income within your plan at a later date, but you can’t elect to lower your payments for a refund of the principal.

Are There Any Age Requirements for Buying an Annuity?

Most plans require that you be younger than 80 years old to purchase an annuity.

Is a Medical Exam Required When I Purchase an Annuity?

No. Medical exams are not usually required to purchase an annuity.

What Percentage of My Assets Should I Use to Buy an Annuity?

That depends on your particular financial situation. We recommend that you speak with an independent retirement financial planner or other trusted advisor when you are evaluating an annuity.

Some retirement financial planners recommend that people reserve at least 40 percent of their retirement assets for unforeseen circumstances. Because most annuities are designed to provide steady income over time, they are not ideally suited to cover large unplanned expenses.

How Are Annuities Different From Life Insurance?

Life insurance pays your beneficiaries a substantial cash benefit should you die during the term of the policy – essentially protecting them against the risk that you might die prematurely, placing them in financial jeopardy. Benefits from life insurance policies are designed to replace “lost” income; they usually provide significantly more than you’ve paid into the policy.

Annuities are completely different – they are designed to provide you with guaranteed income during retirement.

If I Have an Emergency Can I Terminate the Plan?

In most cases, you cannot terminate your annuity once you’ve signed up. Certain outstanding circumstances may, however, enable you to cancel and recover some of your investment.

If I Die Prior to Recovering My Original Investment, What Will Happen to My Payments?

Some annuities offer premium protection as a standard feature. With this feature, you or your beneficiary will continue to receive scheduled periodic payments until the cumulative payments equal your net investment, even if you die beforehand.

In states where a premium tax is levied on annuities, your net investment is your premium less the state premium tax. Some plans also offer an option that provides for a specified number of guaranteed payments to be made to your beneficiary in the event of your death. You can elect to opt for higher annuity payments each month by forgoing these options, but there’s no guarantee that you will recover all or part of your original investment.

What Is the Minimum Investment to Purchase an Annuity?

Generally, it is recommended that you have at least $30,000 to put toward an annuity. However, each individual’s situation is unique.

Can I Buy Inflation Protection?

Reputable annuity providers offer automatic cost-of-living-adjustment (COLA) as a standard feature. COLA will protect you against inflation.

Can I Do a 1035 Exchange on My Annuity?

No. Because annuities carry no cash value, performing a 1035 exchange (exchanging an insurance policy that you own for a new life insurance policy without paying tax on the investment gains) from an annuity to other products is not permitted. However, you can use a 1035 exchange to transfer funds into an annuity.

Can I Buy a Lifetime Income Plan With Qualified Funds?

Yes. Funds from 401(k), 403(b) and other qualified retirement plans can be used to purchase an annuity. In such a case, you can roll the funds over into the annuity without forfeiting tax protection.

What Is the Exclusion Ratio, and How Does It Work?

If you buy an annuity with non-qualified after-tax dollars, the Exclusion Ratio is the percentage of your lifetime income payments that you will not have to treat as income (for federal income tax purposes).

Can an Annuity Cover Both Myself and My Spouse?

You can have your paycheck last for your lifetime alone or until both you and your spouse die.

Can I Specify How My Beneficiaries Will Receive Money After I Die?

You can set up your annuity so that if you die, your beneficiaries will receive payments for a particular period of time. Or, if your annuity contract has funds remaining after you die, your beneficiaries can receive them as a lump sum.

How Do I Decide How Much I Want to Commit to an Annuity?

The larger your initial premium, the larger your paychecks will be. Ideally, you can purchase an annuity that will provide you with enough guaranteed income to cover your expenses in retirement.

NewRetirement Planner

Do it yourself retirement planning: easy, comprehensive, reliable

NewRetirement Planner

Take financial wellness into your own hands and do it yourself retirement planning: easy, comprehensive, reliable.

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