Guide to Retirement Annuities: When Do They Make Sense?

By Nicole Young on December 14, 2022

Nobody knows for certain what the future holds, which can make it difficult to plan out each aspect of your retirement. Even if you think you’ve got a handle on what your lifestyle and expenses will be in retirement, there’s always the possibility that you outlive your nest egg – particularly as life expectancy increases and retirements have the potential to last longer.

Fortunately, there are financial instruments that are designed to help ensure you don’t run out of money during your golden years: retirement annuities. Here, we explore what they are, how they work, and whether one could make sense in certain circumstances.

What are Annuities Anyway?

Annuities are financial contracts issued by insurance companies or financial institutions that provide investors with guaranteed monthly income payments over a long period of time.

Prior to collecting annuity payments, individuals pay into an annuity fund – either with a lump sum payment or through regular installments. This is known as the accumulation phase. At a certain point specified in the contract, the accumulation phase ends and the insurance company or financial institution begins making payments back to that individual, either for a set period of time (e.g., 20 years) or for the rest of the individual’s life. This is known as the annuitization phase.

Traditionally, these types of financial products have been used by individuals looking for long-term financial security, retirement income, diversification, or principal preservation.

What are Retirement Annuities?

Retirement annuities are one of the most popular types of annuities, as they can provide investors with a steady, predictable income stream throughout retirement, which can mitigate the risk of them outliving their retirement savings. The issuer, on the other hand, can benefit by receiving upfront payment, levying early withdrawal penalties, and/or potentially retaining any remaining funds upon an annuity owner’s passing.

While retirement annuities come in many forms, they often fall into one of four major categories:¹

Fixed retirement annuities. This type of retirement annuity offers a fixed payment over the course of the annuitization phase. Some annuities offer a fixed rate for a predetermined number of years, typically at a conservative rate similar to a certificate of deposit. Others offer a fixed rate for the remainder of an individual’s life, with the rate largely determined by the individual’s age. However, if you pass before your money runs out, you might not be able to transfer the remaining balance to your beneficiaries.
Variable retirement annuities. Unlike fixed annuities, payouts from variable Variable retirement annuities. annuities can change month-to-month based on the performance of the funds they’re invested in. With this annuity option, your opportunity for growth can be greater, but it can also be riskier because your payouts are tied to market performance. In some instances, the issuer may allow you to mitigate this risk by purchasing a rider that guarantees a minimum withdrawal.
Immediate retirement annuities. If you already have a nest egg put away for retirement, you can set aside a portion of it to put into an annuity. This type of lump sum payment can allow you to start collecting regular annuity payments immediately.
Deferred retirement annuities. If retirement is still a ways off, but you know you want to include an annuity in your retirement plan, you can choose to make payments towards that annuity over an extended period of time. Depending on whether you’ve selected a fixed or variable annuity, your money can either accrue interest or enjoy tax-free investment growth. On an agreed-upon date, you will stop paying into the annuity and start receiving payments.

Could a Retirement Annuity Work for You?

A retirement annuity might be something to consider if you don’t have a large enough nest egg to feel comfortable with or if you anticipate having difficulties covering your expenses with your projected retirement income. Guaranteed annuity payments can help you meet your monthly cash needs throughout retirement and reduce the likelihood of you running out of money prematurely. In some instances, an annuity might help you plan for long-term care or make your retirement income stream more tax efficient, but be sure to consult with a financial professional before making that assessment.

Thanks to these possible benefits, retirement annuities often appeal to investors who are focused on protecting their future income while minimizing risk.

However, there are potential downsides, too. First, most annuities come with annual fees that could be higher than other investment options. These fees are worth considering because they can have a significant impact over time. Second, once you sign an annuity contract, it can be costly to back out or access the funds you’ve committed – which can make these instruments fairly illiquid.

Additionally, annuity products are often complex financial contracts that can be difficult to understand and navigate for some investors. Because of this, it’s important to have a trusted advisor by your side who can help you determine your retirement goals, weigh your options, and identify whether an annuity might help you meet your individual needs.

_{This material is intended for informational/educational purposes only and should not be construed as tax, legal or investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Certain sections of this material may contain forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are diﬃcult to predict. Past performance is no guarantee of future results. Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption of any kind. Please consult with your ﬁnancial professional and/or a legal or tax professional regarding your speciﬁc situation and before making any investing decisions.}

_{Fixed Annuities are long term insurance contacts and there is a surrender charge imposed generally during the ﬁrst 5 to 7 years that you own the annuity contract. Withdrawals prior to age 59-1/2 may result in a 10% IRS tax penalty, in addition to any ordinary income tax. Any guarantees of the annuity are backed by the ﬁnancial strength of the underlying insurance company.}

_{Please consider the investment objectives, risks, charges, and expenses carefully before investing in Variable Annuities. The prospectus, which contains this and other information about the variable annuity contract and the underlying investment options, can be obtained from the insurance company or your ﬁnancial professional. Be sure to read the prospectus carefully before deciding whether to invest.}

_{The investment return and principal value of the variable annuity investment options are not guaranteed. Variable annuity sub-accounts ﬂuctuate with changes in market conditions. The principal may be worth more or less than the original amount invested when the annuity is surrendered.}

_{¹ Kurt, Daniel. “Retirement Annuities: Know the Pros and Cons.” Investopedia. Investopedia, August 18, 2022.}

_{https://www.investopedia.com/articles/retirement/121416/retirement-annuities-know-pr os-and-cons.asp.}

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