What Are Annuities & How Do They Work? Are They Good Investments?

Have you ever wondered if annuities deserve a place in your retirement portfolio? Picture opening your 401(k) statement and seeing terms like “fixed indexed annuity,” “surrender charges,” and “guaranteed minimum withdrawal benefit.” If those phrases make your head spin, you’re not alone. But here’s what matters: annuities can deliver $2,000, $3,000, or more in monthly retirement income that arrives like clockwork—whether the market crashes 30% or climbs to new highs.

• What are annuities?
• Are annuities safe investments for you?
• Are Annuities a good investment for you?

In this article, you’ll discover the five main annuity types—immediate, deferred, fixed, variable, and indexed—and whether they belong in your retirement portfolio. You’ll see how a $250,000 annuity can generate $1,500 to $2,000 in monthly income, how surrender periods typically run 5-10 years, and how annuities can shield your principal from 2008-style market crashes while still participating in S&P 500 gains (with caps usually at 4-8% annually).

We’ll also break down the specific fees—like 1-3% mortality and expense charges, 0.5-1.5% annual contract fees, and surrender charges that can hit 7-10% if you withdraw early—so you can compare annuity costs to low-cost index funds charging 0.03-0.20% annually.

By understanding how annuities work and weighing the benefits and drawbacks, you’ll gain clarity on integrating them into your broader retirement plan.

Key Takeaways: Are Annuities a Good Investment For You?

With over $2.3 trillion invested in annuities in the US alone according to LIMRA, they are growing in popularity. But are they right for you?

• An annuity is a financial product that provides a steady income in retirement, which can be a good investment for those seeking predictable returns. However, it’s important to consider potential fees and access to funds.
• Annuities function as an income backstop, delivering contractually guaranteed monthly payments ranging from $500 to $5,000+ (depending on your premium investment) that can cover baseline expenses like a $1,200 mortgage, $400 utility bill, and $600 grocery budget. And the tax structure is concrete: your money compounds at the annuity’s stated rate (e.g., 3.5% fixed or variable returns linked to the S&P 500) without annual 1099 forms until you start withdrawals.
• Annuities come in a variety of options – each with its own set of pros and cons.
  – Immediate annuities, or annuitizitation offers a fixed income for a period of time or the oweners life. it is very similar to the way a traditional retirement income pension or social security income works.
  Fixed annuities lock in specific annual percentage yields—for example, 3.5% APY for 5 years or 4.2% for 10 years—comparable to a bank CD paying 4.5-5.0%, but often with slightly lower credited rates in exchange for lifetime income conversion options.- Variable annuities offer the potential for higher gains but come with markmarket risket risk.
  – Index Annuities claim to offer the best of both worlds, but rarely live up to their hype.

Understanding What Are Annuities: A Bird’s Eye View

Annuities are complex financial products that many find confusing. But getting a basic understanding of what they are and how they work is key to determining if they fit into your financial future.

• Annuities provide a unique way to receive guaranteed retirement income. Unlike investments fully exposed to market risk, annuities can offer predictable income you can rely on. They are only issued by insurance companies and come in many forms.
• Need a predictable income floor of $1,500-$3,000 monthly to cover non-negotiable expenses? Annuities transform your lump sum—say $200,000—into contractual monthly deposits hitting your checking account, regardless of whether the S&P 500 drops 40% next year or inflation pushes your grocery bill from $600 to $800.
• Here’s the mechanics: you sign an annuity contract and transfer a premium—$100,000, $250,000, or whatever amount you choose—to an insurance carrier like New York Life or Nationwide. In return, they commit to depositing a fixed dollar amount (e.g., $833/month from a $100,000 immediate annuity at age 65) into your account on the 1st of every month for as long as you live, or for a specified term like 10 or 20 years.

• Learn more about Annuity Do’s and Don’ts here

What Are Annuities – a Definition

You’ve got choices. There are fixed annuities, where you know exactly how much money you’ll get each month.

Then there are variable annuities, where the amount can go up or down based on how investments perform.

Why should you care?
Well, if you’re thinking about your future, especially retirement, an annuity can be a game-changer. It’s like having a mini-pension plan that you set up for yourself.
Plus, the money you put in grows without getting taxed until you take it out. That’s called tax-deferred growth, and it’s a big deal.

So, is an annuity for you?
If you’ve got savings that aren’t in a 401(k) or IRA, an annuity could be a smart move.
But remember, it’s not a one-size-fits-all deal. You need to pick the right type and understand the costs.

Why trust this article?
Michael Ryan is a financial expert, with years of hands on experience as a financial planner.
Michaelryanmoney.com was started to break down the complex financial topics such as the world of annuities, into bite-sized pieces you can understand.

What is The Primary Reason For Buying an Annuity?

The primary reason for buying an annuity are the following:

• The most common reason is to create a guaranteed stream of income in retirement. Lifetime income riders ensure income for life, which can be a valuable asset in retirement planning.
• Annuities eliminate the monthly budget anxiety that comes from checking your brokerage balance—seeing it swing from $500,000 to $350,000 in a correction—and wondering if you can still afford your $2,500 monthly expenses. With an annuity paying $2,000/month guaranteed, you know 80% of your baseline costs are covered, rain or shine. Multiple protection mechanisms exist: principal guarantees (your $200,000 stays $200,000), minimum withdrawal benefits (you can take out at least 5% annually), and death benefit riders ensuring your spouse or heirs receive the remaining contract value.
• Estate planning is another common reason to buy an annuity. An annuity can be used to transfer wealth to heirs without incurring estate taxes. This can be a valuable way to pass on assets to loved ones, protection for dependents, while minimizing capital gains and ordinary income taxes.
• Asset protection is another reason to consider an annuity. Annuities are often used to protect assets from creditors. This can be a valuable tool for people who are concerned about losing assets to creditors in the event of a lawsuit or other legal action.

There are many reasons to consider purchasing an annuity. Retirement planning, estate planning, and asset protection are all common reasons. Annuities can provide a contractual guaranteed stream of income, which can be a valuable asset in retirement. They can also be used to transfer wealth to heirs without incurring estate taxes.

Are Annuities a Good Investment in 2024? Are They Safe?

Many people view annuities as a safe way to ensure they will have income in retirement, but there are some risks to consider.

• Annuities are commitment products with surrender period timelines you need to understand: most fixed annuities lock your money up for 5-10 years, during which early withdrawals trigger surrender charges ranging from 10% in year one, declining 1% annually to zero. Deferred annuities won’t pay you a dime until you elect to annuitize (typically age 60-70), meaning your $150,000 investment sits accumulating value at 3-5% annually for potentially 10-15 years before you see monthly income checks. If you’re 55 and need cash flow at 58, an immediate annuity makes sense; if you’re 55 and don’t need income until 70, a deferred product works better.
• Most fixed annuities pay a static dollar amount: if you lock in $2,000/month today, you’ll still receive $2,000/month in 15 years—but if inflation runs at 3% annually, that $2,000 will only buy what $1,308 buys today (a 35% purchasing power erosion). Your grocery bill that costs $600 now could hit $930, yet your annuity check stays frozen at $2,000. Inflation-adjusted (COLA) annuities exist, offering 2-3% annual increases, but they start with 20-30% lower initial payouts ($1,400/month instead of $2,000) to fund those future bumps.
• Finally, annuities are not guaranteed by the government. This means that if the insurance company that issues your annuity goes out of business, you could lose all of your initial investment.

Despite these risks, an annuity can still be a good option for some people. If you are comfortable with the investment risks and are looking for a way to financially guarantee income in retirement, an annuity may be a good choice for you. So we know some of the risks , and you may feel they are safe. Let’s look at some of the pros and cons:

Incorporating Annuities into Your Retirement Plan

Having worked with retirees for many years, I’ve gained insight into how annuities can fit into retirement planning. I’ve seen effective strategies using annuities, and unfortunately, manipulative sales tactics from some insurance and banking professionals. Drawing on my experience, here are some tips to help you make an informed decision about annuities.

The role of annuities in your retirement depends on your unique situation and goals. But there are some general best practices:

Actionable Advice on Annuity Shopping

• Evaluate whether an immediate or deferred annuity aligns better with your goals based on factors like age and existing savings.
• View annuities as one piece of a diversified retirement plan, not a cure-all solution.
• If pursuing an annuity, work with a fee-only fiduciary advisor, not an insurance salesperson.
• Shop around and evaluate multiple annuity products and providers. Compare fees, payout options, and financial strength of the issuer.
• Use fixed or indexed annuities to guarantee income from a base amount of savings. Allow the rest to remain invested for growth potential.
• Consider an annuity to create guaranteed lifetime income, reducing risk of outliving savings. But don’t put all assets into annuities.
• Time your annuity purchase appropriately – buying too early can limit growth, too late reduces income.
• Consider annuitizing only a portion of your assets in your 70s or 80s to secure income during advanced age. But maintain liquid savings as well. A maximum of 25-50% is commonly recommended.
• Annuitize in phases, laddering into annuities over time rather than committing everything at once.
• Review all fees and contract terms thoroughly. Avoid high fees or opaque terms. and get clarity on surrender charges and limitations.
• Use annuities cautiously or avoid them if you have health issues or low life expectancy. Payouts may cease upon death, without an additional riders on teh policy.
• Assess your personal situation annually – you may need to adjust your annuity allocation as retirement draws closer.

Following these tips will help you incorporate annuities into your retirement plan in a strategic, optimized way. They can provide the growth, diversification, and guaranteed income a sound plan needs.

Now that you know how to effectively include annuities in your portfolio, let’s discuss some final tips for evaluating providers and securing the best rates.

Making Informed Investment Decisions

If you determine annuities may play a complementary role in your retirement portfolio, here are some tips for making wise investment choices:

• Thoroughly research annuity providers – opt for companies with financial strength, transparency, and a reputation for ethical conduct.
• Consider only top-rated, established insurers like New York Life, Northwestern Mutual, and TIAA. Check ratings with AM Best and Moody’s.
• Beware of teaser rates or extravagant claims. Modest return assumptions are more realistic.
• Work with a fee-only fiduciary financial advisor versus an insurance salesperson to avoid conflicts of interest.
• Take time to understand each provision in the annuity contract before signing. Ask questions if anything is unclear.
• Be extra diligent with variable annuities – analyze the investment options and weigh higher fees.
• Negotiate competitive rates, but don’t sacrifice quality for the highest payout.
• Review charges, penalties for early withdrawal, and ability to adjust terms over time.
• Choose lifetime income payouts if you are interested in mitigating longevity risk rather than temporary payouts.

Making well-informed annuity purchases requires research, seeking expert counsel, and protecting your interests. But the peace of mind may merit the extra diligence.

Whether to add annuities to your financial plan depends on assessing your specific retirement goals, timeline, and risk preferences. Weigh the pros and cons carefully. Annuities can provide income stability when used strategically, but they require long-term commitment. Evaluate how they align with your needs.

Are Annuities Safe? Weighing the Pros and Cons of Annuity Investing

Deciding whether to include annuities in your retirement planning requires carefully weighing the potential benefits and drawbacks. Annuities can provide invaluable guaranteed income in retirement but also have disadvantages to consider.

On the pro side, annuities offer:

• Guaranteed Income – Annuities provide reliable income for life, reducing longevity risks. This gives peace of mind knowing you have steady payments you cannot outlive.
• Tax-Deferred Growth – During the accumulation phase, your annuity value grows tax-deferred. This allows for faster growth compared to taxable accounts.
• Income Streams – Annuities can be customized with riders, creating customized income streams aligned with your unique retirement needs and goals.
• Principal Protection – Fixed and indexed annuities protect your principal from market losses, providing an extra layer of security.
• Estate Planning – How do annuities work for estate planning? Annuity owners can designate beneficiaries, bypassing probate and providing a straightforward way to transfer wealth.

However, annuities also come with some potential cons:

• Fees and Charges – Surrender charges apply to early withdrawals. Annuities also come with fees that can add up over time and reduce your overall returns. Be sure to analyze the fees closely.
• Lack of Liquidity – It can be difficult to access your funds if you need them for an emergency. Annuities are intended for long-term goals.
• Complex Contracts – Annuity contracts can have complex terms that make them difficult to fully understand without expert help.
• Securing Income – You pay to receive guaranteed income, so weigh if this tradeoff is worth reducing assets you could invest elsewhere.

Evaluating these pros and cons requires aligning them with your financial objectives and retirement plan. Annuities serve a key role in providing lifelong income but have downsides to consider.

Annuity fees and charges significantly impact your long-term returns and retirement income. Understanding the common fee structures—from upfront sales charges and mortality costs to surrender charges and management fees—empowers you to compare annuity options transparently and make informed decisions that maximize your retirement wealth.

Understanding Annuity Fees and Charges

Fee Type	Explanation
Initial Sales Charges	Upfront fees deducted from your initial investment.
Mortality and Expense (M&E)	Cover administrative and mortality-related costs of the insurance company.
Surrender Charges	Applied if you withdraw money before a specified period, encouraging long-term commitment.
Management Fees	Associated with the investment options within the annuity, covering fund management.
Rider Fees	Optional features like guaranteed income or death benefits may come with additional costs.
Annual Contract Fees	Ongoing administrative fees related to the annuity contract.

Before purchasing an annuity, request a detailed fee breakdown and compare total costs across providers to ensure you’re getting the best value for your retirement investment.

If you are redy to invest in an annuity, be sure to read this too: Do You Have Questions About Annuity Riders Explained

So, are annuities the golden ticket for everyone?
Nope. They’re great for some folks but not for others.

Stick around. I’ve got more wisdom to share. Now let’s explore how to effectively include annuities within the context of your broader retirement vision and investment portfolio strategy.

Making Sense of The 2 Phases of Annuities: Accumulation Phase & Payout Phase

Annuities have two main phases – the accumulation phase where you make payments into the annuity, and the payout phase where you start receiving income. The money you put in can grow tax-deferred.

Then, upon retiring, you can convert your annuity into scheduled payments, providing a paycheck in retirement.

The key benefit that annuities provide is serving as a source of guaranteed income you cannot outlive. This gives peace of mind and certainty in retirement planning. Annuities aim to offer financial security and mitigate risks like longevity risk – the risk of outliving your money.

Now that we’ve covered the basics, let’s dig deeper into the specific types of annuities and how they differ. This will provide crucial context for weighing the pros and cons and deciding if adding annuities to your retirement portfolio makes sense.

The lifecycle of an annuity, from paying into the accumulation phase to receiving income in the payout phase.

Now that we’ve covered the fundamentals of annuities, let’s explore the main types available. Understanding the differences between annuity varieties is important for identifying what aligns best with your financial situation and retirement goals.

• Want to know what your annuities value is? Use our free Present Value Annuity Calculator.

There Are Several Common Types of Annuities To Choose From

Understanding different annuity types is essential for selecting the right retirement income strategy. Each annuity offers distinct characteristics in terms of how they function, their comparable investment behaviors, and their associated risk levels, helping you align your choice with your financial goals and risk tolerance.

Annuity Types and Risk Levels

Type	What It’s Like	Risk Level
Immediate Annuity	Trading 401(k) for pension	Low
Deferred Income Annuity	Saving for later	Medium
Fixed Annuity	Like a CD	Low
Variable Annuity	Like a stock portfolio	High

Match your risk tolerance with the appropriate annuity type to build a retirement strategy that provides both security and growth potential.

Fixed Annuities

Fixed annuities offer returns at a predetermined, guaranteed interest rate. Your funds grow at this set rate, allowing you to precisely calculate your future income payments. The principal and interest are protected from market volatility.

• Learn more about Fixed Annuities Pros and Cons here.

Variable Annuities

With variable annuities, you can invest your funds across a range of investment subaccounts, similar to mutual funds. This provides exposure to the stock market, allowing your account value to grow based on performance of the investments.

What are the risks of variable annuities?
Variable annuities involve market risk, but also allows for potentially higher returns. Which could impact the investment’s return. For example – Ginny, an entrepreneur, chose a variable annuity for potential growth aligned with her risk tolerance.

• Learn more about Variable Annuity Pros and Cons here.

There is a third type, called Equity Indexed Annuities with a participation rate and growth rate. I will not get into depth about them here – since I am not a fan of them.
Though, they are heavily pushed by insurance brokers and bankers. So let me know in the comments below if you would like me to write an entire article about these…

Immediate Annuities

As the name suggests, immediate annuities begin payouts soon after investment. There is no accumulation phase.

You hand over a lump-sum amount and promptly begin receiving scheduled payments. Learn more about the Immediate Annuities Secrets salespeople don’t want you to know.

Deferred Annuities

• Deferred annuities have two phases, accumulation phase and annuity payout phase. You contribute funds which grow tax-deferred. You decide later when to annuitize the contract and begin receiving income payments.
• Deferred annuities accumulate earnings tax-deferred. This tax-deferral provides flexibility in retirement planning.

Choosing between immediate and deferred annuities is a critical decision that shapes your retirement income strategy. Understanding how these two annuity types differ in payment timing, growth potential, flexibility, and risk characteristics helps you select the option that best aligns with your financial goals and retirement timeline.

Immediate vs. Deferred Annuities Comparison

Aspect	Immediate Annuities	Deferred Annuities
Timing of Payments	Begins soon after lump sum payment	Starts at future date, allowing accumulation
Primary Purpose	Provides income for retirees	For long-term savings and future income
Investment Growth	Typically no growth	Tax-deferred growth potential over time
Flexibility	Less flexibility once payments start	More flexibility with contributions and investing
Risk Tolerance	Lower risk with fixed payments	Risk depends on investments, can be higher

Evaluate your retirement timeline and income needs to determine whether immediate or deferred annuities better support your long-term financial security.

Real Talk: My Experience with Clients

I often told my clients, “An immediate annuity is like buying a car with cash. You pay once and enjoy the benefits.” For deferred income annuities, I’d say, “It’s like a garden. You plant the seeds, let them grow, and harvest later.”

Now that you’re familiar with the major varieties, let’s weigh the potential benefits and drawbacks of adding annuities to your portfolio.

Frequently Asked Questions About Annuities

USAA Annuities 101: What Are Annuities?

Conclusion: Navigating the Annuity Maze for a Secure Future

Are annuities a good investment for retirement? Annuities can be a good investment for retirement, offering guaranteed income and financial security.

We’ve covered a lot of ground in this article on retirement planning and annuities. The key takeaways are:

• Annuities can provide guaranteed income for life to manage longevity risk
• But they come with complex fees and restrictions.
• Work with a fee-only financial advisor you trust if considering annuities.
• And remember to diversify – don’t put all your eggs in one basket.

On a personal note, I’ve helped many clients navigate these waters over my 25+ years in financial planning. No two situations are alike, but with careful research and trusted guidance, annuities can play a role in securing your retirement future.

I hope this article provided valuable insights as you plan for your golden years. Please leave a comment below sharing your biggest retirement planning concerns – I look forward to continuing the conversation! And be sure to download my free Annuity Buyer’s Guide for more help weighing your options.

Wishing you a prosperous retirement ahead. Keep striving for your financial goals!

• “Comparing Annuities with Other Retirement Investment Options“
• “The Pros and Cons of Investing in Annuities“
• “How Annuities Fit into a Diversified Retirement Plan“

• Sharing the article with your friends on social media – and like and follow us there as well.
• Sign up for the FREE personal finance newsletter, and never miss anything again.
• Take a look around the site for other articles that you may enjoy.

Note: The content provided in this article is for informational purposes only and should not be considered as financial or legal advice. Consult with a professional advisor or accountant for personalized guidance.