Is an Income Annuity Right for You?

If you’re anything like me, you heard about income annuities for the first time from some old television star during an episode of The Price Is Right. For a long time I never gave annuities a second thought, but now that retirement planning is forefront in my mind, I decided to take another look to see if it could be a good financial move for our family. Here is some information you can use to determine if an income annuity is right for you and your family.

What Is an Income Annuity?

An income annuity is essentially a contract with an insurance company in which you agree to pay them a set amount of money and in return they promise to pay you a fixed payout for a certain period of time (or your lifetime). If this sounds familiar to you, it may be because a pension is the best known example of an income annuity. There are several different types of annuities, but for our purposes we will only address income annuities since they tend to be the most common.

What are the Benefits?

There are several benefits that an income annuity can bring to your retirement savings portfolio. By far the biggest benefit is the guaranteed stream of income. In a way, you can set up an annuity to function much like your current pay structure. For example, you can choose to receive consistent monthly payouts for 30 years so that you always know how much income you will have in a given month. This also gets to the greater point, that you are guaranteed a certain amount as your payout, so while the insurance company takes what you pay in and invests it, if those investments fall short of the payment amounts you’re guaranteed, it’s up to the insurance company to make up the difference. This is a huge difference from your typical 401(k) or IRA where you, as the investor, are on the hook for any market losses. In this way, an income annuity is extremely beneficial in that it guarantees a specific amount of regular income regardless of how the economy is performing. It’s essentially another tool to help mitigate market risk.

What are the Drawbacks?

The drawbacks can also be quite significant. First, annuities are expensive. There are often substantial fees that may be associated with purchasing an annuity. Among these are the commission fees paid to the insurance agent selling the annuity and surrender fees which essentially charge you to terminate your annuity contract. For this reason, you should shop around for the lowest annuity costs. Investment companies such as Vanguard, Fidelity, and TIAA-CREF often offer much lower fees than you would be offered if you were to purchase an annuity directly from an insurance company.

Another drawback is that some annuity withdrawals you make may be taxed at your ordinary income tax rate. While this depends on the type of annuity you purchase and will typically only apply to the portion of your payout that was generated via market growth, this still puts your tax rate for these payouts at a potentially higher rate than your typical capital gains that you would see in the event of a withdrawal from a traditional 401(k) or IRA. Lastly, your plan is only as good as the company insuring it. This drawback is particularly concerning when it comes to purchasing an annuity. Unlike a mutual fund that diversifies your investment, or a bank account that is backed by the FDIC up to $100,000, if the insurance company that you purchased your annuity from goes out of business, your annuity contract goes with them. There is no government body that guarantees those payouts so you need to do your due diligence when you’re choosing who to purchase an annuity from.

Should You Purchase an Annuity?

Whether an income annuity makes sense for you is a highly personal choice. It can be most beneficial in cases where you have already maxed out your contributions to your 401(k)/IRAs. It can also be helpful if you find the stress of ensuring that you have enough money to retire for an unknown period of time to be too much. If you think an annuity might be the right choice for you, start researching your options. Talk to the big investment companies and compare their cost making sure to steer clear of commission costs and surrender fees if possible. There are so many different types of annuities and no one type will fit all investors, so spending ample time researching your options is critical since this is a long term decision that is often difficult to reverse without financial consequences.


Written By: Lindsay Dell Cook

Lindsay Dell Cook is a CPA, finance writer, and founder of Budget Babble. She lives in Philadelphia with her uber supportive husband and adorable daughter. When she's not working, she enjoys spending time with her family, taking their lovable mutt for walks, or reading a good book while buried under a pile of cats.