The Pros and Cons of a Hybrid Annuity

A hybrid annuity combines the features of a fixed annuity and a variable annuity. Hybrid annuities offer guaranteed lifetime income like a fixed annuity, plus potential for growth like a variable annuity. Limitations of hybrid annuities include higher fees than many other investment options, lower guaranteed interest rates than many fixed annuities and lower potential for growth than many variable annuities.

A financial advisor can help determine whether hybrid annuities make sense for you.

Hybrid Annuity Basics

Hybrid annuities, also called indexed annuities, blend the features of fixed annuities and variable annuities. They consist of two investment accounts, one invested like a fixed annuity for a steady rate of return and the other earning interest that varies based on the performance of a market index. Popular market indexes these annuities track include the S&P 500 and the Nasdaq 100.

Sales of hybrid annuities grew rapidly when interest rates were very low and investors were searching for more yield without taking on too much risk. The fixed annuity portion of a hybrid annuity is guaranteed to provide at least a minimum level of lifetime income. The variable portion’s yield will vary and may be higher, lower or even negative, depending on the performance of the index.

Annuities are produced and sold by insurance companies, which are regulated by state insurance departments. Fixed annuities are not considered investment products by federal investment regulators like the Securities and Exchange Commission (SEC). However, the SEC does oversee variable annuities and some types of index annuities.

Hybrid Annuity Pros

Hybrid annuities offer retirees a compelling middle ground between security and opportunity. These financial products combine features of both fixed and variable annuities, providing a guaranteed income stream while allowing for potential growth based on market performance. For those planning to retire at 70, this balance can be particularly attractive as it helps protect against inflation while ensuring consistent income during your retirement years. The pros include:

Reliable lifetime income: The fixed income portion of the annuity is guaranteed to be paid for the life of the annuity owner.
Growth potential: If the tracked index increases in value, the return of the variable portion of the annuity may increase.
Less risk: Because they include a fixed annuity component, hybrid annuities are less risky than variable annuities.
Higher rates than safe alternatives: Other low-risk investments, such as certificates of deposit, generally pay lower interest than hybrid annuity yields.
Customization: You can customize your annuity’s holdings to conform to individual preferences and objectives such as matching your risk profile. If you are more risk-averse, for instance, you can set up the low-risk fixed annuity portion to be larger compared to the higher-risk variable portion and vice versa.

Many hybrid annuities include death benefit provisions that can protect your investment for your heirs. These features can ensure that your beneficiaries receive at least your original investment amount or possibly more, depending on market performance and specific product features. This aspect provides peace of mind that your retirement planning can benefit not just yourself but potentially future generations as well.

Hybrid Annuity Cons

Hybrid annuities, while offering certain protections, come with significant limitations that retirees should carefully consider. These financial products typically carry higher fees than simpler investment options, which can substantially erode your retirement savings over time. The complex fee structures often include mortality and expense charges, administrative fees and costs for various riders that can add up quickly. The cons you need to know include:

High fees: Annuities in general have high sales commissions as well as other fees. Hybrid annuity owners must also pay investment management fees to cover the costs of managing the variable component.
Rate caps: Hybrid annuities offer the chance for higher returns if the index does well, but insurance companies limit the returns. They may have rate caps based on a percentage of the index return, charge spread fees to keep the interest earned down to a percentage of the index return or use other sorts of caps.
Limited fund selection: Hybrid annuities are likely to offer fewer funds for investment than variable annuities.
Hybrid annuities are complicated: Investors need to carefully read the annuity documents to understand features such as rate caps.
Tax-free growth: Annuities can enable investments to grow tax-free, but payouts are taxed as ordinary income rather than at the generally lower capital gains rate. Also, any withdrawals taken before age 59.5 may incur penalties.

Remember that annuity guarantees are only as strong as the insurance company backing them. Unlike some other retirement vehicles, hybrid annuities expose you to the financial stability of a single institution. If that company experiences financial difficulties, your retirement income could be at risk despite contractual guarantees.

How To Choose the Right Annuity

Before selecting an annuity, clarify what you want it to accomplish in your retirement plan. Are you seeking guaranteed income, growth potential, or legacy planning? Your specific retirement goals will guide which annuity type best suits your needs. Consider how an annuity fits within your broader financial strategy, especially if you’re planning to retire at 70.

Different annuity types serve different purposes. Fixed annuities offer predictable income with minimal risk, while variable annuities provide growth potential with market exposure. Indexed annuities fall somewhere in between, offering some market participation with downside protection. Immediate annuities start paying right away, while deferred annuities allow your money to grow before payments begin.

Annuities come with various fees that can significantly impact your returns. Look for transparent fee structures and understand surrender charges, mortality expenses, and administrative fees. Lower-cost options typically preserve more of your retirement savings over time. Remember that the cheapest option isn’t always the best as value matters more than price alone.

Bottom Line

Hybrid annuities can be useful options for retirement savers who want a reliable stream of income plus the potential to earn more than a fixed annuity can offer. They also may be attractive to people who have already saved as much as possible in a 401(k) or traditional IRA and want to save more in a tax-advantaged account. They tend to be less appealing to a younger saver who may need to withdraw money before age 59.5 or who wants to take a more aggressive approach to investing and is comfortable with added risk.

Tips for Retirement Planning

You can take your questions about different types of annuities and their role in retirement planning to a financial advisor. 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.
How states tax retirees vary widely, with some being markedly friendlier than others. A handful of states have no state income tax. Others don’t tax Social Security benefits. Retirement and pension withdrawals may or may not be taxed, depending on the state. SmartAsset’s retirement tax calculator makes it simple for you to include taxing concerns when you are considering where to retire. States are ranked by the level of taxes imposed on retirees and additional details can be summoned with a click.