4 Questions to Ask Before Adding an Annuity to Your Retirement Plan

Annuities are a worthy option for savers looking to add an element of protection to their retirement strategy. The key: Work with an independent adviser and understand WHY each product is being recommended.

Four people in business suits hold up papers with questions marks on them in front of their faces.
(Image credit: Getty Images)

There are certain topics you learn to avoid while at a dinner party. Religion. Politics. Medical issues. Guns. Gossip. Gluten. I’d also throw any discussion of annuities into that mix.

Not only because people can have such a visceral reaction to the word -- based mostly on those "annuities are the devil!" speeches you often hear from so-called experts and celebrity financial gurus. But also because it means you're wading into a complicated subject that many people may find hard to understand.

It's a conversation you definitely should have with your financial professional, though, if you're looking for more conservative options for your retirement.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

Despite the verbal bashing, annuity sales have been on the rise as the financial industry shifts (thanks to aging Baby Boomers) to a greater focus on preservation and income-driven products and strategies, and away from accumulation at all costs. Many savers also are looking at using annuities to create their own reliable income strategy when their employer doesn't offer a pension plan.

If you're thinking about adding an annuity to your portfolio, here are some questions to consider:

1. What kind of annuity would work best for you?

Financial professionals often say that investments and insurance contracts are not "one size fits all," and this is especially true of annuities. Much of the criticism comes from a misunderstanding of how they work -- and that's because these products can be structured in so many different ways. There are, however, a few basic types.

  • Immediate annuities are annuity contracts purchased with a single lump sum. You lose control over your deposit through something called "annuitization," but payments start almost immediately, and they guarantee an income stream you cannot outlive.
  • Fixed annuities operate much like certificates of deposit, but without FDIC insurance and with higher penalties. On the plus side, you will receive a fixed rate of interest for a fixed period of time, typically at a higher rate of return and accompanied by withdrawal and death benefit provisions.
  • Fixed index annuities blend safety of principal with returns tied to some type of external market index. They have more upside potential than a fixed annuity without the downside risk of a variable annuity.
  • Variable annuities offer the full growth potential of the market, but also the full downside potential. These annuities may be accompanied by some type of rider guaranteeing a lifetime income or death benefit for the insured.

2. How can you be sure you're getting the most for your money?

It takes a vigilant consumer and diligent adviser to choose the annuity that's most suited for you out of the sea of options. You may find one variable annuity with 4% in annual fees and another with just 1%. You might find a fixed index annuity with a 60% participation rate (the participation rate is the percentage of the index's gain that the insurer will credit to the annuity) and another with only 20%. You may find a fixed annuity with a 2% guaranteed rate and another with 3.5%. You can say the same thing about virtually any type of investment, of course; the diversity isn't exclusive to the world of annuities.

To make sure you're getting the annuity that can help you best pursue your retirement goals and objectives, work with an independent adviser who isn't limited to certain product offerings, and be sure you understand WHY each product is being recommended. One of the best ways to do this is to ensure you are always presented with more than one option in order to understand why a specific recommendation makes the most sense. It's your money, not your adviser's, so be sure you make the decision.

3. What are the pros and cons of any annuity your adviser is proposing?

Regardless of the financial vehicle, there is always a downside, and to make the most educated decision for your financial future, you need to take the time to understand the pluses and minuses. For example, fixed index annuities have seen a dramatic increase in use among financial planners, according to LIMRA, an insurance industry research and development organization.

So, here's what you would need to know about fixed index annuities.

Cons include:

  • You won't make as much as you potentially would if you invested directly in the S&P 500.
  • You'll have limited annual withdrawal privileges, typically ranging from 5% to 10% of your account value.
  • There can be high penalties for distributions that go beyond your free withdrawal privileges -- often in the double digits.
  • The terms (surrender charges) are long -- usually from five to 15 years.

Pros include:

  • The long-term average accumulation rate is currently better than that of other conservative financial vehicles, like certificates of deposits and investment-grade bonds of similar maturity.
  • Your principal is protected from market losses through the financial strength of an insurance carrier. This is why you want to make sure you're working with a carrier that's highly ranked through a rating agency such as A.M. Best or Comdex.
  • Riders can be added to create guaranteed death and long-term care benefits regardless of insurability. They do vary by product and typically have an extra cost.
  • Riders can be added to generate guaranteed lifetime income that is typically at a higher rate than an immediate annuity without losing total control of your contract.
  • Tax deferral is often pitched as a pro, but it could become a con depending on future tax rates.

4. What are some other features I should know about?

Again, the options are pretty much endless. Your adviser can help you find the right fit when it comes to tax efficiency, inflation protection, survivor benefits and more. You also should discuss how much of your nest egg you want to put into an annuity, because it should never be all of it.

Despite what you hear from the pundits, annuities are a worthy option for savers looking to add an element of protection to their retirement strategy. Structured correctly, you can benefit from a consistent and reliable income stream during retirement; principal protection can allow for an increase in equity exposure and growth potential for the remainder of your portfolio; and you may even choose to add long-term care and death benefits.

Don’t count on your dinner companions — or even a TV personality — to fill you in on the many critical details. Take your time, review all the different contracts available and arm yourself with questions before you meet with your adviser. Then you can make an informed decision as to whether an annuity is appropriate for you.

Kim Franke-Folstad contributed to this article.


This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Casey B. Weade, CFP®
President, Howard Bailey Financial Inc.

Casey B. Weade is president of Howard Bailey Financial Inc. in Indiana and author of the book "The Purpose-Based Retirement." Weade, a financial professional, hosts The Purpose-Based Retirement radio and TV shows in the Fort Wayne area. He earned the prestigious Certified Financial Planner™ (CFP®) certification in addition to being a Retirement Income Certified Professional® (RICP®). He is also an Investment Adviser Representative (IAR), as well as life, accident and health insurance licensed and Long-Term Care Certified.