What Type of Annuity Is Best For Me?

Well, it depends ... on when you want your payments, what kind of a guarantee you are looking for and whether you're willing to take a little risk to pursue a possibly higher return. Breaking annuities down to their basics could help steer your decision.

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When you think about retirement, what’s your biggest fear?

If you’re worried about running out of money, you’re not alone. Survey after survey has found that building enough income to last through a long retirement is one of the top concerns for baby boomers and the generations behind them.

Of course, there’s a good reason for their anxiety. Prior generations typically could rely on employer-sponsored pension plans, as well as Social Security, to provide them with guaranteed paychecks in retirement. But those pension plans are quickly disappearing. And the future of Social Security seems to be constantly in question. (As it is, if you have average earnings, the Social Security Administration says those benefits will replace only about 40% of your income.)

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Clearly, there’s a growing need out there for another source of guaranteed income.

According to the 2018 Retirement Confidence Survey from the Employee Benefit Research Institute, four in five workers expressed an interest in the possibility of adding a guaranteed lifetime income product to their portfolio, regardless of whether it was an in-plan investment option or a separate product purchased at the time of retirement.

And yet, I wonder what the response would have been if that same study had used the word “annuity.”

Actually, I don’t have to wonder. According to the 2018 Guaranteed Lifetime Income Study by Cannex, though 73% of respondents reported high interest in guaranteed lifetime income products, when the word “annuity” was used, a third expressed a lower interest in the same product.

I get it. All annuities are not created equal — and neither are the financial professionals who sell them. The contracts can be complicated. Fees and commissions used to be higher than they are now. And you still need a good guide to help you understand exactly what to expect — and what to avoid.

But annuities have seen a tremendous evolution over the past 30 years — and especially recently. To broad-brush them all as unworthy is a mistake, particularly if you need additional guaranteed income in your retirement plan.

I like to break up the annuity “world” into several segments, each of which has its own uses and may be implemented for people at different stages in life.

A Matter of Timing

First, annuities can be broken down based on when your payments begin:

Immediate Annuities.

I think of these as the old-school annuities our parents would have had. They are, for the most part, simple in concept: You give the insurance company a lump sum, and it promises to pay you income for the rest of your life and your spouse’s life, or for a designated period. Just as you’d expect from the name, an immediate annuity begins paying income checks immediately upon being funded.

There are many nuances beyond those basics, but the bottom line is that you lose control of the money you put into the annuity and shift all the risk to the insurance company that guarantees it.

Who might be interested in this type of annuity? Although this was once the only option for anyone seeking a steady income stream in retirement, and is still often what comes to mind when people hear “annuity,” it’s fallen somewhat out of fashion because of the loss of control. Yet, for those whose No. 1 concern is an income stream they can’t outlive—trumping concerns about inflation, growth or legacy planning — this may be something they discuss adding to their financial toolbox.

Deferred Annuities.

Most annuities sold these days fall under the banner of the deferred annuity. Like immediate annuities, they are intended for income and have an insurance component, but they differ in that their incomes streams won’t begin until a later date in the future. Deferred annuities allow their contract owners the opportunity to grow the value of the underlying contract using various crediting methods.

Who might be interested in this type of annuity? Those who anticipate wanting a steady and reliable income in retirement but who may not need that income stream right now will likely consider a deferred annuity. Which one will largely depend on what crediting method is most in line with their goals and expectations.

A Matter of Math

Next, deferred annuities can be broken down based on how your payments are calculated:

Fixed Rate Annuities.

The growth rate for the contract value in a fixed rate annuity is guaranteed by the insurance company. The contract owner pays either a lump sum or a series of payments into the contract, and that sum is credited growth by the insurance company at a minimum fixed rate, usually pretty modest but hopefully enough to keep up with inflation.

Who might be interested in this type of annuity? Because of the fixed, regular credits of interest, these tend to be suitable for folks who like to invest in similar instruments, such as CDs.

Variable Annuities.

These annuities have market exposure through sub-accounts that look and act like mutual funds and ETFs — except the sub-accounts grow tax-deferred. The annuity works in two phases. During the accumulation phase, you contribute money and allocate it to the investment funds of your choice. Many times there are no investment restrictions, and your adviser can help you build a diversified portfolio to match your objectives and risk tolerance.

Of course, market exposure comes with market risk, meaning that you could lose your contract’s credits and principal if there’s a significant market correction. During the payout phase, you receive income from your annuity most commonly as a series of monthly payments that last your entire lifetime and your spouse’s lifetime. It is possible to take it as lump sum, but be aware of potential tax liabilities and potential surrender costs if you make a large withdrawal too early.

Variable annuities can carry higher expenses and fees than other types. And they may become even more expensive if you add certain benefits (or riders), such as a living benefit that provides income even if you outlive your investment, and a death benefit that guarantees your beneficiaries will receive a certain minimum amount of money as a legacy. The insurance benefits you purchase are added expenses, which if used correctly, can create excellent value and are sometimes hard to beat.

Who might be interested in this type of annuity? For people who want the gains that can come with market exposure and are OK with some volatility, variable annuities can be a great solution. Many times these annuities make the most sense for those who are further out from retirement.

Fixed Index Annuities.

These hybrid products combine features of both variable and fixed rate annuities. Your principal is guaranteed, as with a fixed rate annuity, but you also may get to participate in some market-related growth. There are many variations, but the most common types are cap-rate or participation-rate annuities. With a cap rate of 6%, for example, the annuitant will enjoy market increases up to 6% but no higher. With a participation rate, the insurance company allocates only a portion of the growth of the index to the annuitant — typically 35% or higher.

Both types usually come with the promise that you won’t lose anything to the market — it’s just that your upside is limited. As with variable annuities, you can add living and death benefit features to fixed index annuities — at a cost. Many fixed index annuities have no portfolio fees until you add benefits, which makes them appealing to investors who are looking for an alternative to bonds.

Who might be interested in this type of annuity? For those who have some time before needing an income stream, and who would like the opportunity for higher gains but without the risk to principal that comes from being exposed to market risk, this absolutely makes sense. Especially as people approach retirement, it’s imperative that they search for guarantees for a portion of their portfolio, but there are limited options, and often fixed index annuities can serve in this role.

Some Final Thoughts

These are just the annuity basics; there are many factors to consider when choosing the right product for you — including liquidity, risk, fees, tax consequences and your time horizon. Annuities are not backed by the federal government — they are the obligation of the issuing company, so it’s important to shop around and carefully research any potential investment.

Despite many improvements to today’s annuities, it’s still a good idea to consult with a tax professional and a financial adviser with a deep understanding of these products.

Kim Franke-Folstad contributed to this article.

Important Disclosures:

Annuities are long-term investments designed for retirement purposes. Withdrawals of taxable amounts are subject to income tax and, if taken prior to age 59½, a 10% federal tax penalty may apply. Early withdrawals may be subject to withdrawal charges. Optional riders have limitations and are available for an additional cost through the purchase of a variable annuity contract. Guarantees are based on the claims-paying ability of the issuing company.

Variable annuities are sold by prospectus only. Investors should carefully consider objectives, risks, charges and expenses carefully before investing. The contract prospectus and the underlying fund prospectus contain this and other important information. Investors should read the prospectus carefully before investing. For a copy of the prospectus contact your financial adviser.

Securities offered through Securities America, Inc. A Registered Broker/Dealer. Member FINRA/SIPC. Advisory services offered through Cooper McManus, a Registered Investment Advisory Firm. Link Financial Advisory, Cooper McManus and Securities America are not affiliated.


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.

Richard London, Certified Financial Planner™
Founder, Link Financial Advisory

Richard London is a CERTIFIED FINANCIAL PLANNER™ and founder of Link Financial Advisory (www.linkfinancialadvisory.com). As an independent financial planner, he goes into the market and finds the best solutions and strategies for his clients. Richard grew up and lives in Las Vegas with his wife and two children, and he holds a bachelor's degree in finance from the University of Nevada, Las Vegas.