Should You Buy an Annuity in Retirement?

If you're considering an annuity, you're probably trying to solve a specific problem: how to create income that lasts as long as you do.

One of the biggest risks in retirement is longevity risk—the possibility of living longer than expected and eventually running short of income. An annuity can help address that risk by converting a portion of your savings into a guaranteed stream of income that continues regardless of how long you live.

That guarantee can be appealing if you want greater confidence that essential expenses such as housing, healthcare, utilities, and groceries will be covered throughout retirement. The tradeoff is that you're giving up some flexibility and some long-term growth potential in exchange for that certainty.

How We Think About It 

An annuity may make sense if you want additional guaranteed income beyond Social Security.

If Social Security covers most of your essential expenses but leaves a gap, an annuity can provide additional monthly income to help cover the difference. The goal is not to maximize returns. The goal is to create a dependable income stream that helps cover the expenses you can't afford to miss.

Why Would You Buy an Annuity?

At its core, an annuity is a risk-management tool designed to help protect against longevity risk and provide predictable income throughout retirement.

When you buy an annuity, you're trading a portion of your savings for a guaranteed income stream. In exchange, you reduce some of the uncertainty that comes with relying entirely on investments for retirement income.

For many people, that certainty has value. Knowing that your housing, utilities, healthcare, and other essential expenses are covered can make retirement feel more secure.

How We Think About Annuities

We generally think of an annuity as a supplement to Social Security.

Social Security already provides a guaranteed monthly income stream. If that income falls short of covering your basic expenses, an annuity can sometimes help fill the gap.

The objective isn't necessarily to cover every dollar you spend. You may travel, dine out, spoil your grandchildren, or pursue hobbies that require additional spending. Those expenses can often be funded from your investment portfolio.

Instead, we focus on making sure your essential expenses are covered first. Once those necessities are covered by dependable income sources, the rest of your portfolio can remain invested for future growth.

What Is the Biggest Risk of Buying Too Much Annuity?

The biggest risk is inflation.

Most annuities provide a fixed payment. While that payment may feel sufficient today, your expenses will likely increase over time. Healthcare costs, insurance premiums, housing expenses, and everyday living costs rarely stay the same for long.

When you purchase an annuity, you're also reducing the amount of money that remains invested for long-term growth. That matters because growth is one of the primary ways your portfolio keeps pace with inflation.

If too much of your money is committed to fixed income sources, there is a risk that your expenses eventually outgrow your guaranteed income. Years down the road, you may find that your Social Security and annuity payments no longer cover the same percentage of your expenses that they once did.

That's why we typically view annuities as a way to create an income floor, not as a replacement for your investment portfolio. The annuity provides stability while your remaining investments continue working to help offset inflation over time.

Why We Prefer Simplicity

If you've spent any time researching annuities, you've probably discovered that the industry offers an endless number of variations.

Some products promise market participation. Others offer income riders, inflation adjustments, death benefits, or various guarantees designed to address specific concerns.

Some of these features can be useful in the right circumstances. The challenge is that every additional feature comes with a cost. More complicated annuities often carry higher fees, larger commissions, and contract provisions that can be difficult to evaluate.

Our preference is generally to keep things simple. If your goal is growth, use investments. If your goal is guaranteed income, use an annuity.

Trying to combine both objectives into a single product often creates unnecessary complexity. We generally prefer using brokerage accounts, IRAs, and 401(k)s for long-term growth while using annuities only for the specific purpose of creating guaranteed income.

Why We Often Prefer Immediate Annuities

The most common annuity we evaluate is an immediate annuity.

You don't need to buy it years before retirement. You don't need to spend a decade accumulating assets inside the contract. When you decide you want additional guaranteed income, you purchase the annuity and begin receiving payments according to the contract terms.

It's simple, straightforward, and easy to understand. You exchange a portion of your assets for a predictable monthly income stream.

For many people, that's exactly what an annuity should be.

What About Liquidity?

One of the most overlooked downsides of annuities is the loss of flexibility.

When you purchase an annuity, you are intentionally giving up some access to your assets in exchange for guaranteed income. That tradeoff is often worthwhile when your goal is creating a reliable income stream, but it is still a tradeoff that deserves careful consideration.

This becomes important when life doesn't go according to plan. You may face a major healthcare expense, need to help a family member, or encounter a significant home repair or other unexpected cost that requires a large amount of cash. If too much of your wealth is committed to annuities, meeting those expenses can become more challenging.

For that reason, we generally encourage people to think carefully about how much of their portfolio they commit to guaranteed income products. An annuity can provide security, but maintaining flexibility elsewhere in your retirement plan is equally important.

Why You Shouldn't Rush Into an Annuity

One of the most important things to remember is that annuities are usually available later.

If you're uncertain today, you can revisit the decision next year. You can revisit it after retirement. You can revisit it after you have a better understanding of your spending needs.

What is much harder is reversing the decision after you've already signed the paperwork.

Depending on the contract, surrender charges may apply if you withdraw money early or terminate the annuity before a specified period ends. Those charges can sometimes be substantial and may last for years.

That's why it's important to fully understand what you're buying before making a commitment. An annuity can be a valuable tool, but it's a decision that deserves patience.

Questions to Review Before Buying an Annuity

Before purchasing an annuity, ask yourself:

• What expenses am I trying to cover?

• How much income does Social Security already provide?

• How much of my portfolio will remain invested for growth?

• How will I handle a major unexpected expense?

• Are there surrender charges or restrictions on withdrawals?

• Am I buying this for income security or because I am concerned about market volatility?

The answers often provide more clarity than the product brochure.

Annuity FAQ

What is the primary purpose of an annuity?

The primary purpose of an annuity is to provide guaranteed income and help address longevity risk.

Are annuities investments?

We generally view annuities as income tools rather than growth investments. Their primary role is creating predictable income, not maximizing returns.

Do annuities keep up with inflation?

Many annuities provide fixed payments that do not automatically increase with inflation.

What is a surrender charge?

A surrender charge is a penalty that may apply if money is withdrawn from certain annuity contracts before the surrender period ends.

Can I buy an annuity later?

In most cases, yes. Annuities are generally available when you decide you want additional guaranteed income.

Final Thoughts

If you're looking for guaranteed income, an annuity may deserve consideration. If you're looking for growth, there are usually better tools available.

For many people, the most effective approach is surprisingly simple. Use Social Security and, if needed, an annuity to help cover essential expenses. Keep the rest of your portfolio invested for long-term growth and inflation protection.

That approach allows each part of your retirement plan to do the job it does best. Your guaranteed income provides stability. Your investment portfolio provides flexibility, growth, and the ability to adapt as your needs change over time.

In many cases, keeping those roles separate leads to a simpler and more effective retirement plan.

Disclosure

Risk Disclosure: Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance does not guarantee future results.

This material is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. The content is developed from sources believed to be providing accurate information; however, no warranty, expressed or implied, is made regarding accuracy, adequacy, completeness, legality, reliability, or usefulness of any information. Consult your financial professional before making any investment decision. For illustrative purposes only.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific situation with a qualified tax professional.