Annuities: Do You Need Guaranteed Income In Retirement?

Annuities, a type of guaranteed income, can give you peace of mind in retirement. After all, having an annuity means you can count on a payment arriving regularly regardless of how the stock markets are performing.

But is an annuity a must-have? Some 401(k) plan sponsors, insurance companies and money managers think so, but not every financial pro is on board with that assessment.

That’s what Cerulli Associates, the wealth and asset management research firm, found when it recently polled asset managers. In 2019, 42% of asset managers believed a retirement income solution needed a guaranteed component to be effective, but in 2024, only 37% believed that to be true.

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The slight shift in sentiment comes as annuities are finding their way into more 401(k) plans, thanks to the SECURE Act 2.0. On the books since the end of 2022, the Act enables annuities to be included in 401(k)s. The idea is to create a lifetime guaranteed income stream for retirees.

While annuities have fans, including among retirement savers, the complexity, fees and nuances associated with this type of financial product are leaving some financial advisers questioning if they are necessary.

“If you look at the results of the survey over five years, there’s more doubt whether or not it’s actually a necessity,” says Idin Eftekhari, senior analyst at Cerulli. “Some folks are now looking at it as it's nice to have, not a need to have.”

Annuities: Is it worth it to give up liquidity?

A big knock on annuities, says Eftekhari, is the fact that you forfeit liquidity when you put money into an annuity. To fund an annuity, you either invest a lump sum or make a series of payments over time, and in exchange, you get paid out at a later date.

Once the free look period, or the window in which you can cancel the annuity, expires, which is typically ten to 30 days, you can no longer access that money without paying penalties and fees.

But if something comes up in retirement that requires you to access a significant amount of capital, you can’t touch the annuity.

That means you’ll have to tap your savings or draw down from other retirement accounts. The less money you have in, say, a 401(k) or IRA, the less opportunity you have to benefit from growth and compounding.

Plus, Eftekhari says a lot of annuities don’t have inflation protection, which means the money you put in today may not be worth the same amount in five, ten, or twenty years when you begin receiving payments.

Some annuities offer inflation protection, but they tend to be more costly. “If most participants were truly educated about what they are getting, they would probably say no, thank you,” says Eftekhari.

Are the fees worth it?

Another factor to consider when it comes to annuities: the fees. Depending on the type of annuity and extra bells and whistles, fees can range from 1.5% to 4% on average. Within a 401(k) plan, it can be difficult to determine the fees. Over the years, those fees can add up and take away from your returns.

“Annuities tend to be quite expensive,” says Jane Delashmutt O’Mara, a certified financial planner at FBB Capital Partners. “If there are any products out there that guarantee something, they come with a price tag. You have to understand what you are paying for and what the price tag is.”

That’s not to say annuities don’t make sense for some individuals. If someone wants to spend down assets to qualify for Medicaid, doesn’t want to invest in the stock markets, or has won a lawsuit or the lottery and has a large sum of cash, then an annuity can make sense, says O’Mara.

They can also make sense in a couple of other instances:

The thought of running out of money in retirement keeps you up at night. Annuities that guarantee income through your lifetime can give you peace of mind and a good night’s sleep. This kind of annuity can be either an immediate annuity or a deferred annuity.

An immediate annuity is typically purchased with a lump sum and begins receiving payments within 12 months or less. A deferred annuity is designed to grow on a tax-deferred basis, providing guaranteed income to the annuitant starting on a particular date they choose. The savings period for deferred annuities can last from a few years to decades, and the money grows over time.

You crave safety but a better return than you can get from a CD. Fixed annuities tend to outperform bank CDs because they are held longer, giving the insurance company more time to invest and grow the money. At last check, a fixed annuity has a yield of around 5% while a bank CD is paying about 3% to 4%.

But an annuity should be part of an overall financial plan, not the only component, says O'Mara. An alternative to an annuity is to build a portfolio of bonds or a bond ladder that generates income each year as the bonds mature, says O’Mara. Spread out over the years, bonds can give predictable income in retirement.

There is a place for guaranteed income

Rick Sweeney, director of insured solutions at RBC Wealth Management, says many clients are worried about outliving their savings and some will turn to an annuity to protect against that. In addition to guaranteed lifetime income, some clients purchase annuities to give them downsize protection.

Typically, the annuities are part of a well-diversified plan that includes different streams of income, he says.

“Annuities are not well suited for everybody," adds Eftekhari. “When you are sitting down reviewing the paperwork (with annuities), it's at least a 40 or 50-page contract you are signing with the insurance company. Most people don’t have time to read the fine print, only to realize after the fact what they purchased.”

A balanced approach

Ultimately, the best approach may be a balanced one, where you have a little bit of everything. That’s the case for clients at Boldin, the maker of financial and retirement software.

Of the company’s 41,000 PlannerPlus subscribers, roughly 3,000 have 100% of their expenses in retirement covered through guaranteed income. The average expenses covered by guaranteed income are 54%. That is typically derived from Social Security, pensions and annuities.

“What people try to do is have enough guaranteed income to cover necessary expenses like food, housing, insurance, health care and transportation, and use their investment portfolio for fun money such as travel, entertainment and gifting,” says Nancy Gates, lead educator & financial coach at Boldin. “The most important thing is to have a long-term financial plan tailored to your personal circumstances.

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