The Key to Choosing the Right Annuity: Do Your Homework
Here are some of the pros and cons of annuities, along with an explanation of the different types. Which might work for you?


Most of us have heard of annuities, but few understand how they work. Annuities can be a powerful addition to a retirement plan. In short, they can protect your savings while also providing you with higher-than-average rates of return.
An annuity is a contract between you and an insurance company where you make payments through a lump sum or contributions in exchange for future income. The insurance company invests these funds for you throughout the accumulation phase where they grow tax-deferred.
However, annuities are complex and often misunderstood, so it's important to do your homework by researching which annuity may best suit you and your retirement plan.

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.
Pros of annuities
Annuities are most commonly used as an investment tool for those in or very close to retirement. An annuity provides the purchaser with a fixed income stream. The payouts will typically last for a lifetime, with the payout agreed at purchase. This can help provide peace of mind for the retiree and help them to avoid outliving their assets.
Annuities have other benefits as well, depending on which type you choose. They can be a relatively safe investment option compared to others. The insurance company has to pay the annuity income they promised to the buyer, giving you a guaranteed income stream.
Annuities also provide flexible payout options, such as monthly, quarterly and annual payments or a lump sum. Unlike other retirement accounts, like IRAs or 401(k)s, annuities have no contribution limits. This makes them a great option for anyone who wants to put more money away for retirement.
Cons of annuities
While annuities can be a great investment choice, they are not perfect. One of the reasons why many people choose not to invest in annuities is because of the possibility of high costs and fees. This can be investment management fees, administrative fees or expense fees, which could significantly reduce your returns over time.
If you want to get out of an annuity contract, it may cost you. Many companies make it difficult to leave your annuity by adding high surrender charges, which could end up being a large percentage of the value of your contract. You may not be able to get out of the contract when you want either, as many annuities come with a limited surrender period.
Which annuity is right for you?
There are five different types of annuities, so which one is right for you? The most common, and often easiest to understand, are fixed annuities. These annuities guarantee a minimum payment and are not impacted by market volatility, so it's easier to anticipate your monthly payments. This annuity will grow at a fixed interest rate determined by the insurance company you purchased it from.
A variable annuity can be riskier and more expensive. Unlike fixed annuities, the interest rate can change with market fluctuations. They can also come with a variety of rider fees. A rider is an optional enhancement you can add to your annuity at an additional cost. These are designed to help you modify your contract and help protect what is important to you. A variable annuity uses several investment options, like stocks and bonds, to determine payouts and grow the principal. You will choose the risk that you want for your contributions — low, moderate or high — and in turn your payouts will increase or decrease depending on the state of your investments.
Immediate annuities are designed to provide a guaranteed lifetime payout and payments begin right after purchase. This type of annuity is funded by a large, one-time contribution.
Similar to an immediate annuity, a deferred annuity provides payouts in exchange for a large sum of money. However, these payouts do not begin immediately. The dollars grow tax-deferred until you are ready to begin receiving payments.
An indexed annuity provides returns that are linked to a specific market index. If the market does well, your return will go up, and even if it performs poorly, you won’t lose money on your principal. This is good for people who want the potential for growth while still being protected. The main difference between an indexed annuity and a fixed annuity is how their interest works. With a fixed annuity you are guaranteed a fixed interest rate, while an indexed annuity pays interest based on the performance of the market.
When deciding whether an annuity is a good investment for you, first, fully understand all the fees, payouts, participation rates and structure of the annuity to help you choose the right type for your retirement. Sitting down with a financial adviser, particularly one who is a fiduciary and well-versed in annuities, can help you navigate the complexities of annuities and protect your retirement.
Related Content
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
Robert Cannon has more than three decades of experience working with investors, businesses and hedge funds across the United States. He focuses on creating lifetime income plans for retirement. Robert guides his clients through a specific wealth management process that is designed for financially successful individuals, couples and families.
-
Stock Market Today: It's Going to Stay Choppy for Stocks
Auto-focus can show us a lot about uncertainty on the ground and in the stock market.
By David Dittman Published
-
Costco’s 4.5-Pound Tiramisu Cheesecake Might Be Your New Favorite Dessert
If you haven’t visited your local Costco bakery to check out the Kirkland Signature Tiramisu Cheesecake, you'd better get there early, they are flying off the shelves.
By Kathryn Pomroy Published
-
Stock Market Today: It's Going to Stay Choppy for Stocks
Auto-focus can show us a lot about uncertainty on the ground and in the stock market.
By David Dittman Published
-
What Would $1.46M In Savings Do For Your Retirement Lifestyle?
Americans think $1.46 million is the ideal amount of money to have saved for retirement, according to a survey. What would that amount of money mean for your lifestyle in retirement?
By Maurie Backman Published
-
Revocable Living Trusts: The Good, the Bad and the Ugly
People are conditioned to believe they should avoid probate at all costs, but when compared with living trusts, probate could be a smart choice for some folks.
By Charles A. Borek, JD, MBA, CPA Published
-
How to Plan for Retirement When Your Child Has Special Needs
When your child has special needs, your retirement plan should include a plan for when you'll no longer be able to care for them yourself. A five-step guide.
By Christopher M. Butterworth, ChSNC®, CRPS, CLU® Published
-
Stock Market Today: Auto Tariffs Send Stocks Lower
The main indexes snapped their win streaks after the White House confirmed President Trump will talk about auto tariffs after the close.
By Karee Venema Published
-
Is Your IRA Protected in Bankruptcy?
Can creditors take some or part of your IRA funds if you file for bankruptcy? Learn more about the federal protections that exist and to what extent they protect your IRAs.
By Donna LeValley Published
-
What Retirees Need to Know About Taxes
Take steps to avoid a surprise tax bill and underpayment penalties.
By Sandra Block Published
-
My Husband Is Terrible With Money. I Worry He'll Quickly Spend Our $1.3 Million Nest Egg. How can I Ever Retire?
We asked expert financial advisers and therapists to weigh in.
By Eileen Ambrose Published