- 4-Minute Article
- Jan 30, 2018
5 Questions to Ask Yourself About Annuities
Examine these benefits and considerations of annuities to help decide if they could be a good fit for your plans for retirement.
Updated: October 3, 2022
- What is an annuity?
- How does an annuity work?
- Should I consider having an annuity in my portfolio?
Close to 80% of older Americans report they are increasingly concerned about how inflation could affect their spending power, according to a survey from Alliance for Lifetime Income and CANNEX.1 Guaranteed streams of income may help reduce anxiety about sustaining retirement savings and can help people maintain their lifestyle during retirement. Over 70% of people ages 55 to 75 place a high value on having guaranteed income to supplement Social Security.2
For some people, annuities can be a valuable addition to a portfolio that includes Social Security benefits, retirement savings, and other investments because annuities can offer an element of protection and guaranteed income. There are many options in the annuity market, and annuities might not be right for everyone. Understanding how they work can help you determine whether an annuity might make sense as part of your diversified plan for retirement. Here are five questions to consider:
1. Is there a gap between potential retirement income sources and expenses?
Review your retirement savings, portfolio investment mix, and sources of retirement income against projected retirement expenses and potential unexpected costs (e.g., medical expenses). If there is a gap between retirement expenses and income, an annuity might help.
An annuity can offer some protection against outliving savings. In exchange for a single payment or multiple payments into an annuity, the insurance company agrees to pay a guaranteed stream of income. With some types of annuities, this guaranteed income lasts throughout the annuity owner’s lifetime, regardless of market performance.
A financial professional can help determine whether an annuity could be an appropriate solution for gaps in your retirement income plan.
2. What kind of access to your money do you need?
If a financial plan already includes liquid assets that can be accessed immediately and in full, annuities may be a good complement. But they might not be a fit for someone with no other sources of liquidity in their portfolio.
Assets in some types of annuities have better growth potential the longer they remain in place. While some types of annuities allow portions of the account value to be withdrawn for income needs, annuity owners typically can’t withdraw the full account value to be withdrawn for income needs, annuity owners typically can’t withdraw the full account value in the early years of the contract without potentially paying a withdrawal charge. For example, a withdrawal charge might start at 7% of the withdrawal amount during the first year of ownership in the annuity and decline by one percentage point annually until year 7 or 8 when the charge is eliminated.3
3. Could additional tax-deferred options be helpful?
Tax-deferred savings vehicles like IRAs and 401(k)s can help build retirement assets by allowing money to grow without an income tax bill until the money is withdrawn. Annuities can also provide tax-deferred earnings for retirement.
For example, with a deferred annuity that’s funded with after-tax money, any growth generated is tax-deferred until withdrawn, at which point it's taxed as ordinary income. Keep in mind that withdrawals from an annuity prior to age 59½ may be subject to a 10% federal tax penalty.
A financial professional can help examine retirement savings and discuss tax-deferred, taxable, and tax-favored options.4
4. Are you willing to pay fees in exchange for benefits?
Like other service providers, insurance companies charge fees to provide the features and benefits of some types of annuities. For example, in the case of variable annuities (VAs), some of these fees include:
- Mortality and expense risk charges cover the insurance company’s cost to guarantee a lifetime income or a death benefit.
- Investment management fees are charged by the funds and pay the investment firms for the fund managers’ expertise and other expenses related to the variable annuity’s underlying investments.
- Optional rider fees pay for benefits and features, such as guarantees that all purchase payments will be returned to the annuity owner through a series of withdrawals.
Read Understanding Variable Annuity Fees for an overview of some fees associated with variable annuities as well as the features and benefits those fees cover. Your financial professional can also help explain the benefits behind various fees.
5. Do you have products and investments in your financial portfolio that help reduce the impact of negative market performance?
A market downturn can have a big impact on retirement savings, especially early in retirement when people begin taking withdrawals. If the account value drops, it can be difficult to recoup that loss in future years – and the account value may never catch up to where it might have been without the market dip.
Annuities can offer some protection against the effects of market volatility. Depending on the type of annuity, this is done by guaranteeing a minimum annual return or minimum level of income, regardless of market performance, or by cushioning the account value from a portion of market declines.
When it comes to planning for income during retirement, there is no one solution. Your financial professional can help you evaluate whether adding an annuity to your overall plan can help achieve retirement goals.