Want Guaranteed Income In Retirement? Find Out If Annuities Are Right For You

Key Takeaways

• Many investors, nervous about the U.S. stock market and the economy, are seeking guaranteed income in retirement.
• Annuities are a type of guaranteed income product that investors can purchase, but experts say they’re not right for everyone.
• Some financial advisors recommend fixed index annuities, which offer protection against downside risk, but offer lower returns than the market.

Many investors, nervous about the U.S. stock market and the economy, are seeking guaranteed income in retirement.

A recent survey by American Century Investments found that more than half of investors (54%) were interested in guaranteed lifetime income options in their workplace retirement plan or outside of it.

In the past, retirement savers would rely on Social Security and pensions for a regular income stream. However, with fewer pension plans out there and Social Security benefits expected to dwindle in the future, many investors are turning to annuities instead.

“A lot of people retiring today don't have that option, so then they have to take their savings and buy their own pension. So that would be using an annuity,” said Michael Resnick, a Senior Wealth Advisor at Alera Group.

Annuities are a financial product, typically offered by an insurance company, with a promise to regularly pay a certain amount of money over a specific period of time.

According to data from LIMRA, an insurance industry trade body, annuity sales in the first half of 2024 jumped 20% to $216.6 billion and are expected to exceed a record $400 billion by the end of the year.

While there may be a case for annuities in some portfolios, experts say, they are not for everyone.

When Do Annuities Make Sense?

For investors who are risk-averse and worry about volatility, having a portion of their retirement nest egg in annuities may help them sleep at night, said Resnick.

He gives the example of a widowed client who was able to weather the 2008 great recession because of the guaranteed income and capital protection she received from an annuity.

And market fluctuations are on the top of many investors’ minds—more than half of respondents (56%) in the American Century Investments survey think that today’s market is so volatile that people their age need to be more conservative with their money.

“It’s money that you cannot outlive,” said Dawn Santoriello, a certified financial planner and founder of DS Financial Strategies, adding that annuities are useful even though past mis-selling of the product has created a negative perception around them.

Len Nassi, a CFP, is a fan of fixed index annuities, which offer returns tied to the performance of a certain stock market index like the S&P 500. With fixed index annuities, your downside risk is minimized, but your potential return is capped too. 

“There's always a cap, meaning that if the S&P 500 does 20%, you’re not going to get 20%. But if it goes down 10%, you don't lose a nickel,” said Nassi.

This reduced return is on account of participation rates and interest caps that fixed index annuities are subject to. Your contract will define your participation rate, which means that your return is restricted to a fraction of the index’s full return. For example, if the participation rate is 75% and the index gains 10%, you would be credited 7.5%. Furthermore, if there’s an interest cap of 6% on that annuity, you still wouldn’t receive 7.5%, you could only receive up to 6%.

Who Should Avoid Annuities?

One of the biggest issues with annuities in general is that they are complicated products, so investors may need to read the fine print to figure out whether it’s a worthwhile investment.

Nearly half (48%) of annuity customers surveyed by J.D. Power said they didn't completely understand the costs and fees associated with their annuity.

When you buy an annuity, you are also typically paying a substantial commission to the agent who sold you the product, as well as administrative expenses such as underwriting costs and fund management fees. Any money going towards these expenses is not getting invested.

Santoriello also said annuities may not be a great choice for younger investors (those below the age of 50) or those who think they’ll need their money before the surrender schedule or tenure of the contract is up.

If you need the money prior to that, you could face penalties from the annuity issuer as well as the IRS. The insurance company that sold you the annuity can levy surrender charges on you for pulling your money out early. If you're under 59½ years of age, you could face a 10% tax penalty from the IRS for an early withdrawal from an annuity.

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