Is an Annuity a Good Investment?

Annuities are popular financial products that often guarantee income throughout the course of your retirement. While you may even have access to customizable features and riders, you’ll likely have to pay high fees and may also end up taking home less than you would by investing your money elsewhere. Note that those who sell annuities often receive extremely high commissions for doing so, though. If you’re thinking about an annuity and crafting a retirement plan, consider speaking with a financial advisor.

What Is an Annuity, and How Do They Work?

Simply put, an annuity is a financial contract between an insurance company and an individual that allows the individual to pay money now in exchange for a guaranteed and steady stream of income in the future. The individual who has the annuity either pays for it all up front or in a series of regular payments.

As the names would suggest, an immediate annuity begins paying out right away, while a deferred annuity begins paying out after a certain amount of time. Annuities can also use a different structure depending on the needs of the individual. They can pay out over the course of a lifetime, or they can pay out for just a set amount of time.

There are also two other annuity structures: fixed and variable. With a fixed annuity, the rate of return for the individual investor is set and won’t fluctuate throughout the life of the annuity. Some fixed annuities can be indexed to a specific index fund or market index as well.

When it comes to a variable annuity, the insurance company you buy the annuity from will invest your money in different funds and accounts, paying out based on the performance of those funds and accounts. You can also be in control of the investments in your annuity if you have a variable contract. On the other hand, it can also be riskier in the case of a market downturn.

Is an Annuity a Good Investment?

Annuities have both advantages and drawbacks, and their suitability depends on your financial goals and situation.

There are many valid criticisms about annuities, but there are also several benefits, depending on your financial situation and financial goals. These are the pros and cons to consider when determining if an annuity is a good investment for you.

First and foremost, an annuity guarantees your income. Even in the event of a market downturn, the insurance company must pay you the amount agreed upon in the contract, making annuities a very stable investment. However, if the insurance company goes out of business, you may lose your investment. Therefore, it is critical that you only work with stable and reputable insurance companies.

Another reason that an annuity may be a good investment is the customizable money management features. You can typically add things like minimum income benefits that guarantee a certain regular payout, even during a market downturn.

You can also add a spousal provision that allows payments to continue when you die as long as your spouse is still living. A death benefit provision allows dependents of the annuity to receive a payout upon the annuitant’s death.

In some cases, an annuity may be a great addition to your overall retirement plan. For example, if you have already maxed out your other retirement account options, an annuity can provide another option. It may also be a good investment if you come into a large sum of money. In this case, an annuity can help you avoid the risk of spending it too quickly. Instead, think about an annuity that pays out over a set number of years.

However, an annuity typically is not the best investment if you are using it as your sole source of retirement income.

Why Annuities Can Be a Bad Investment

Annuities are often the subject of heavy criticism. This is mainly because they can provide subpar returns when compared with relatively simple investment strategies. Those using a deferred annuity as the primary option for financing their retirement, for example, will almost certainly be better off first investing in an individual retirement account (IRA) or a 401(k). These other retirement accounts provide similar, if not better returns, and don’t carry the same fees.

One of the largest drawbacks of annuities is the fact that you’ll pay high fees in comparison to similar products. While fees differ between insurance companies, you’ll usually end up paying more than you would investing in funds.

There are also usually maintenance charges and operational charges that you’ll have to pay. This obviously adds to the cost and decreases what you end up with in your pocket. Plus, the commissions for financial advisors and brokers are higher than they are for other retirement accounts. In fact, they can typically be in the realm of 7%. As a result, it’s easy to see why salespeople would direct clients towards annuities as retirement income streams.

Annuities may also subject owners to surrender charges. These come about if they need to withdraw money from the annuity before several years have elapsed. Additionally, since annuities are tax-deferred, you may be charged a 10% early withdrawal penalty. However, these drawbacks may also be true for other retirement accounts as well.

When Does an Annuity Make Sense?

An annuity may be useful after you have made the maximum contributions to other retirement accounts, such as an IRA or 401(k), and still want to save more on a tax-deferred basis. In this situation, an annuity serves as another channel to continue building retirement assets without paying taxes on growth each year.

It can also work well if you come into a significant sum of money, such as an inheritance, a settlement or the sale of a business. You can convert it into dependable income rather than risk spending it too quickly. Structuring those funds as annuity payments can create consistency and control.

For individuals approaching retirement without a pension, an annuity can serve as a personal replacement, supplying guaranteed payments that, combined with Social Security and other savings, help reduce the risk of depleting assets too early.

This product may also appeal to conservative investors who prioritize stable income over maximizing returns. Even if the growth potential is lower than that of stocks or mutual funds, the assurance of ongoing payments, regardless of market swings, can be attractive.

Annuities can also support family planning needs. Certain contracts include joint or survivor options that allow benefits to continue for a spouse or dependent, making them part of a broader financial and legacy strategy.

Bottom Line

Annuities can provide steady income in retirement, but their value depends on your age, savings, goals, and comfort with trading growth for security.

Annuities can be a useful tool for some retirement strategies, but whether they are right for you depends on factors such as your age, current savings and long-term goals. While they often come with higher fees and may not match the returns of other retirement accounts, they can still be valuable if you have already maxed out other options or want to convert a lump sum into steady income over time. For many investors, the decision comes down to whether the security of guaranteed payments outweighs the potential for higher growth in other investments.

Retirement Planning Tips

Planning for retirement involves complex financial decisions and a financial advisor can offer you the guidance that you need to make a plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’re going at retirement planning by yourself, it’s a good idea to prepare fully. SmartAsset has you covered with lots of free online resources that can help you plan for the future. For example, check out SmartAsset’s retirement calculator.