Evaluating Annuities: Pros and Cons

Annuities provide guaranteed income and tax benefits. If you’re looking for predictability and security, these may be appealing. The downsides are high fees and the potential for lower returns compared to other investments.

Before making a decision, it's wise to compare annuities with other retirement options. Think about how they fit with your financial goals and risk tolerance. Balancing the positives and negatives can guide you to a smarter retirement strategy.

Let’s take a closer look at the pros and cons of annuities, and how they can fit into your retirement plan.

Key Takeaways

• Annuities can be a valuable tool for securing a steady income stream during retirement.
• There are four basic types of annuities: fixed, variable, indexed, immediate, and deferred annuities.
• It offers benefits like guaranteed income, tax advantages, customization options, and more.
• However, it's essential to consider the potential drawbacks, such as fees, liquidity issues, and varying returns.



Understanding the Basics of Annuities

Annuities are a way to secure a steady income during your retirement. They come in various types, each with unique features and benefits.

What Are Annuities?

An annuity is a financial product sold by insurance companies.

When you buy an annuity contract, you make either a lump-sum payment or a series of payments. In return, you get regular payouts that can start immediately or in the future. These payouts can last for a specific period or the rest of your life.

Many annuities are like private pensions that offer more flexibility and control. Both offer predictable income for covering everyday expenses in retirement.



The main difference is this: annuities are bought from an insurance company. Meanwhile, pensions are usually benefits from employers.

Different Types of Annuities

No two annuity plans are the same. The types of annuities differ based on the length of premium payments, guarantee period, interest rate, and other factors. Understanding these types can help you choose an annuity that fits your financial goals.



Here’s a rundown of the most common types of annuities.

Fixed Annuity

If you’re looking for stability and guaranteed payments, then fixed annuities are perfect. This annuity type provides regular payments at fixed intervals. It also offers a guaranteed rate. This means your retirement income doesn’t change even if there are market fluctuations.



Fixed annuities are ideal for conservative seniors who prioritize security over high returns.

Variable Annuity

If you're open to taking on a risky option, variable annuities might be worth considering. This allows you to invest your money in one or more sub-accounts like a 401(k) or mutual fund. The retirement funds you get vary based on the performance of your investments.



While it offers the potential for higher and tax-deferred growth, it also comes with the risk of losing value. If the investment choices perform poorly, you could lose money.

Indexed Annuity

Don’t want to play it too safe or risk too much? The middle ground between fixed and variable annuities is indexed annuities.

In indexed annuities, the annuity company will invest your money using the stock market index you select. Some of the market’s leading indexes include:

• S&P 500
• Dow Jones Industrial Average
• Nasdaq Composite
• Russell 1000

As the contract holder, you may put all your money in one index or split it across several. Your returns are linked to the performance of the index fund. While you won't experience the full ups and downs of the stock market, you will see some growth if the index performs well.



Since an indexed annuity provides a balance of moderate market risk and reward, this is great for conservative investors. You can still benefit from capital gains and earn indexed interest without the risk of losing money.

Immediate Annuity

For those who need an income stream right away, you may consider immediate annuities. Once you pay a lump sum, your guaranteed income starts immediately.



This helps if you're just entering retirement and need to start drawing income from your savings right away. There’s no need to monitor your investment, which means it provides peace of mind with reliable payments.

Deferred Annuity

For those who don't need income right away, you may consider a deferred annuity.

With a deferred annuity, you put off withdrawals until you retire. In the meantime, your money earns interest, which you can use as steady monthly payments later in retirement.



It's an effective strategy for those who want to maximize their savings growth. It also defers taxes until payouts start. This can be beneficial if you're planning for long-term retirement needs.

Pros of Annuities

Annuities come with several key benefits for seniors. This includes guaranteed income, tax advantages, and flexibility through various riders. Such benefits can make an annuity an attractive option for your retirement planning.

Guaranteed Stream of Income

Imagine retiring and knowing you'll get a monthly check no matter what. The guaranteed income of annuities can give you that peace of mind.

When you invest in an annuity, you can receive regular payments for life or a specified period. This can give you peace of mind, especially if you're worried about outliving your savings.



If you’re a retiree who wants to have a steady cash flow, annuities can be a solid option when you need stability and predictability.

Tax Advantages

Annuities also come with tax benefits. When you invest in an annuity, your investment grows tax-deferred. This means you don't pay taxes on the earnings until you withdraw the retirement savings. This can help your investment grow faster over time.



For example, if you put money into a savings account, you'd pay taxes on the interest each year. With an annuity, you can delay those taxes, potentially allowing your money to grow more. When you start taking withdrawals, you'll pay taxes at a lower rate if you're in a lower tax bracket during retirement.

Flexibility and Riders

Did you know that you can tailor your annuity contract to suit your retirement needs? There are different types of annuities, allowing you to choose one that fits your financial goals and risk tolerance.

Whether you want a guaranteed income or aim to participate more in the stock market, there’s a suitable annuity for you.



Additionally, annuities provide flexibility through riders. These are optional features that you can add to your annuity for an additional cost. They provide extra benefits like lifetime income, long-term care, or death benefits.

For instance, a rider can allow you to get a lump sum payment in case of an emergency. Or, you might add a rider that provides additional income if you need long-term care.

Death Benefit

Most annuity contracts include death benefits as a rider. When you pass away, your beneficiaries receive payments or at least the amount initially invested. This helps ensure your loved ones are financially secure even after you're gone.



In some sense, annuities and life insurance are similar because of the death benefits. However, annuity beneficiaries may pay income tax on death benefits. On the other hand, life insurance proceeds aren't includable in gross income.

Estate Planning Benefits

Some annuities allow for beneficiary designations. This can simplify asset transfers and potentially avoid probate.

Let’s say your annuity has a remaining balance upon death. Your named beneficiary can quickly access these funds. That’s because annuities allow beneficiary designations.



The remaining funds can be paid without going through probate. This can simplify the transfer of assets and reduce legal costs. Annuities can impact your estate planning. So, make sure to consult a financial advisor for advice tailored to you.

No Contribution Limits

For 2024, the 401(k) contribution limit is $23,000, and $69,000 for the combined employee and employer contributions.

Unlike 401(k) plans or IRAs, annuities don’t limit how much money you can invest. This allows you to save without the contribution limits associated with retirement accounts. Aside from the annual contribution limits, annuities don’t have the income restrictions that IRAs have.



This makes annuities ideal for high-income individuals who may want to save more for retirement. You can freely choose how much you’d like to allocate among different investments.

Cons of Annuities

Like other financial products, annuities have drawbacks. In this section, we’ll discuss their cons like high fees, commissions, and limited access to your money.

High Fees and Commissions

Cost is one of the biggest drawbacks of annuities. They often have high administrative fees that can reduce your overall returns. Annual fees to keep your annuity active range from 0.3% to 3% of your account value each year.

For example, if you have $100,000 in annuity, you could pay up to $3,000 in fees annually.

Annuities are typically sold by insurance agents, not financial advisors. That means they earn commissions on annuities they sell you. Sales commissions can be as high as 7% to 10% of your investment.



For a $100,000 annuity, that could mean $7,000 to $10,000 in commissions. These annuity fees cut into your potential gains, making it harder for your investment to grow.

Surrender Charges and Penalties

If you need to withdraw money from your annuity early, you may face surrender charges. These penalties are for accessing your money before a certain period, usually 6 to 10 years.

For instance, withdrawing $10,000 early might incur a 7% charge, costing you $700.



The Internal Revenue Service (IRS) also imposes penalties for early withdrawals before age 59½. This penalty is normally 10% of the withdrawal amount on top of regular taxes.

Lack of Liquidity

Annuities are not very liquid investments. Once your money is in, it’s challenging to access it without incurring penalties. This can be a problem if you need sudden access to cash during an emergency. Consider how much access to your money you might need before committing to an annuity.

Inflation Risk

One of the main enemies of annuities is inflation. It decreases the purchasing power of your money invested in annuities.

If you have a fixed annuity, your income payments remain the same, which means their value could decrease over time because of inflation. Imagine you receive $1,000 a month. If prices rise, that $1,000 buys less goods.



To protect against inflation, consider an inflation-protected annuity. These annuities adjust payments based on inflation rates, helping to maintain purchasing power.

Get a Free Consultation Today

Annuities can provide a steady income, but they come with certain risks and costs. When buying one for retirement, you need to study the ins and outs of the annuity contract.

Confused about annuities or retirement savings? Leonard Financial Solutions has you covered.

Our Moorestown retirement planning advisors are here to help you get personalized rates and quotes now from all the top carriers.



We’ll help make retirement plans work for you. Schedule an appointment and see the difference we can make!