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Types of Annuities to Consider for Retirement


Annuities can provide retirees with a guaranteed stream of income, but choosing the right type is key to making the most of these products. Making the selection requires learning about the major features of the types of annuities most popular for retirement planning. It’s also essential to get an understanding your own needs for financial support in retirement. Finally, you’ll want to assess concerns such as fees, liquidity needs and the annuity company’s financial stability. Partner with a financial advisor to compare annuity choices.

Retirement Annuity Basics

An annuity is a contract with an insurance company. You buy one by making either a single, large lump-sum payment or a series of smaller payments, typically stretching for several years. In return, the insurer sends you regular payments beginning either immediately or at some future date. Payments can be set to last for a certain number of years or, when used for retirement, for the life of the annuity buyer.

Annuities benefit from favorable tax treatment. When you use your savings to purchase an annuity, your savings grow tax-deferred. Upon withdrawal, you pay ordinary income tax on the portion representing earnings. Similar to 401(k) plans and other tax-advantaged retirement savings accounts, there is typically a 10% penalty for withdrawals before age 59 1⁄2.

In retirement planning, annuities are particularly useful for hedging against market risk and life expectancy risk. That’s because they can guarantee income for life regardless of how long you live or how markets perform. Some annuities can also continue payouts to a surviving spouse. However, you give up control over the lump sum in exchange for this security.

Retirement Annuity Choices

A woman making a list of questions to identify the best type of retirement annuity for her needs.

Annuities come in many varieties with a broad menu of different options. However, the three main structures of annuities used for retirement funding are fairly straightforward. They include:

Fixed annuities. These offer a minimum guaranteed interest rate for a set timeframe, which can range from one to 10 years. The insurer declares a new guaranteed rate at the beginning of a new year or other period. Fixed annuity payments remain the same over time.

Variable annuities. These invest your purchase payment in securities like stocks and bonds. Without a guaranteed rate of return, payouts fluctuate based on performance of these underlying investments. Variable annuities carry exposure to market risk but offer potentially higher returns than fixed products.

Indexed annuities. These hybrids provide a minimum guaranteed rate combined with the possibility of higher returns linked to a market index, such as the S&P 500. Even if the index declines, your account will never earn less than the minimum rate. However, caps also limit the amount of positive index performance you can access. 

Any of these types of annuities can vary in the timing of payments. Immediate annuities begin payouts within 12 months after purchase, while deferred annuities have an accumulation stage where funds grow tax-deferred before eventual distribution.

Making the Right Choice

Your answers to some key questions help identify the which type of retirement annuity might work for you. Questions to ask include:

  • What is your risk tolerance? Variable and indexed annuities carry some market risk. More conservative investors may prefer fixed products.
  • What are your income needs? Consider if you require payouts that never vary or can accept flexibility. This guides the choice between fixed versus variable options.
  • How long will you need income? Lifetime payout products make sense for those with greater longevity expectations.
  • What are your liquidity needs? Assess if you will need access to the lump sum in the future. Deferred annuities have longer lockup periods than immediate ones.
  • How much can you afford to invest upfront? Larger lump sums allow bigger ultimate payouts. However, some annuities accept smaller periodic contributions.
  • What fees work best for your budget? Less affluent retirees may need to optimize for lower-cost products.

The ideal product aligns with your risk appetite, age, life expectancy, income requirements, liquidity needs, investable assets and tolerance for fees. Annuities also vary in terms of fees, withdrawal options and death benefits. It can be challenging to sort through all the options, but thoroughly investigating alternatives prevents making an expensive mistake.

Retirement Annuity Limitations

Along with benefits, annuities can also present notable downsides. Here are four things to watch out for:

  • High fees. Insurers levy annual mortality, expense and administration charges ranging from 1.25% to 5%. These can seriously erode long-term performance.
  • Liquidity risk. If you have to withdraw funds early, you are likely to be charged surrender fees. These typically start at around 10%, when cashing your annuity in the first year. Make sure your withdrawal plan matches your likely future needs.
  • Issuer instability. If the insurer or insurance company has financial troubles, your payouts could shrink or stop completely. Carefully assess an issuer’s ratings and financials beforehand.
  • Tax burdens. While funds grow tax-deferred, payouts face ordinary income rates up to 37% federally. Taxes can eat significantly into net proceeds.

Bottom Line

A woman considering the benefits and drawbacks of taking out an annuity.

The right annuity product can greatly enhance retirement security by guaranteeing lifetime income. Annuities lack a one-size-fits-all approach, however, and there are many varieties. Figuring them all out can take time and effort. To pick the right one for you, research options thoroughly and integrate annuities into your overall plans. Be wary of pitfalls such as high fees and make sure the insurance company is financially sound.

Tips for Retirement Planning

  • Consider meeting with a financial advisor to discuss whether annuities fit into your retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Use SmartAsset’s Retirement Calculator to measure your progress toward funding retirement.

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