Is an Annuity a Good Choice for You? Questions to Ask

Annuities can help you save for retirement, reduce risk, cut your taxes and guarantee a lifetime income. But they’re not right for everyone.

How can you tell if an annuity is right for you? And if one is, which kind would best meet your needs?

Deferred annuities — fixed, variable and fixed-indexed — help you save more for retirement while deferring taxes on earnings. Immediate annuities pay current income for people who need more income right away, usually retirees.

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Ask yourself the following questions to decide whether an annuity is right for you:

• Do I have enough cash reserves to meet my expected needs? Most annuities tie up your money for a number of years. They’re thus appropriate only for people who can afford to set aside some of their money.
  
• Does it look like my Social Security and pension income (if any) won’t quite cover my expenses in retirement? Estimate how much income you’ll need in retirement. An annuity can fill a shortfall by paying a guaranteed lifetime income. Equally important, it can serve as longevity insurance — a hedge against the financial risk of living to a very old age.
• Will I need supplemental income for anyone else besides myself, such as a surviving spouse should I pre-decease them? If so, then the reliable income an annuity provides could be beneficial.
• Would I benefit from tax-advantaged savings? Most people will benefit, but if you’re in a low tax bracket, an annuity won’t be quite as compelling.

Once you decide that an annuity is right for you, these questions can help you decide which type or types will suit you best.

• When do I expect to need the annuity's income payments? If it’s right now or within a few months, you should be looking at an immediate annuity. If you’re saving for retirement years in the future, a deferred annuity makes sense.
• Will I be able to withdraw money from the annuity if I should need it? An immediate annuity usually has no liquidity, because your money has been converted into an income stream. Deferred annuities usually offer unpenalized access to some of your money. Different types have different amounts of liquidity.
• Do I want a guaranteed interest rate and guaranteed principal? If your answer is yes, then you’ll want a plain fixed annuity, which provides a set rate for a number of years, much like a certificate of deposit. This type of annuity is called a multi-year guaranteed annuity. Advantages over CDs include tax deferral and often a markedly higher rate of interest. Savers who are willing to commit their money for five years or longer as of mid-April 2021 can earn 2.90% or more, guaranteed and tax-deferred. See this summary of current annuity rates.
• Am I willing to risk losing principal for a chance of higher earnings? If so, then consider a variable annuity, which is much like a set of mutual funds within an annuity wrapper that provides tax deferral and optional benefit guarantees.
• Can I “have my cake and eat it too?” If that’s your goal, consider a fixed indexed annuity, which offers the potential for higher interest earnings while guaranteeing your principal. However, unlike a traditional fixed annuity, it pays a fluctuating interest rate, which can go as low as zero when the stock market declines. Also, there are caps on upside gains. Over the long term, a fixed indexed annuity stands a good chance of outperforming bonds, CDs and standard fixed annuities.
• When do I plan on using the money that's in the annuity? Immediate annuities begin making income payments shortly after purchase, while deferred annuities leave the funds inside your annuity to accumulate over time before converting to an income stream in the future. If you think you’ll need to use the funds before age 59½, a deferred annuity won’t be suitable because of tax penalties on early withdrawals. On the other hand, the longer you can leave your money in a deferred annuity, the more attractive it becomes, because tax deferral is powerful in the long term.
• What’s my risk tolerance/where is my money invested now? Your risk tolerance will depend on several different factors, such as your age, your investment time horizon, your retirement goals, and your comfort level with volatility. The good news is that annuities can offer a wide range of different options to choose from based on your specific risk tolerance, as well as the financial goals that you're trying to accomplish. If the bulk of your savings is in the stock market, consider a standard fixed annuity to reduce your risk profile. On the other hand, if almost all your money is in safe, no-growth holdings like bank accounts and money market funds, consider adding growth potential via a variable or fixed indexed annuity.
• Do I understand the tax implications? Annuities have tax advantages, but withdrawals of earnings are subject to ordinary income tax. Typically, you’ll be taking income from your annuity during retirement when your tax bracket will likely be lower. If you are purchasing the annuity contract for an Individual Retirement Account (IRA) or another type of retirement program, consult with a tax professional regarding eligibility and tax consequences.