Are Annuities a Safe Retirement Investment?

Annuities can be a safe and strong investment for retirees who understand the risks associated and select the proper type of annuity for their personal situation.

When you purchase an annuity, you typically pay into it over time or deposit a lump sum into it all at once. In exchange, you eventually receive a guaranteed stream of payments that can last the rest of your life.

Annuities can be attractive to retirees because it can help ensure they don’t run out of money in retirement. Even if your main savings like a 401(k) or IRA are exhausted, the payments from an annuity will continue as long as you are alive.

It may make sense for some people to use annuities as part of their retirement plan if they have the resources to do so. It can be a great way to supplement a retiree’s main savings and Social Security payments with an additional income stream.

An added benefit is that annuities are tax deferred and typically don’t include a contribution limit.

But like with most types of financial products and investments, there are risks attached that are important for individuals who are interested in buying an annuity to understand.

There are several factors that can make it risky to invest in an annuity as part of your retirement strategy.

One risk is the possibility of dying before you recoup or exceed the value of the annuity. The great benefit of purchasing an annuity is the fact that its eventual payments will last for the rest of your life, even if those payments exceed the principal.

But if you die early into retirement, then the annuity may be a poor investment since you put a lot of money into a product that you weren’t able to maximize. For this reason, annuities may not always make sense for those with serious health problems or who don’t expect to have a long lifespan.

The potential risks involved with purchasing an annuity will vary depending on the type you are interested in. Some styles carry more inherent risk than others.

One type that comes with a lower level of risk but also lower reward is a fixed annuity. According to the Financial Industry Regulatory Authority, you’re locked into a set interest rate and set payouts with a fixed annuity.

This allows you to know exactly how much money you will be receiving from your annuity without having to worry about dramatic fluctuations. The tradeoff is that there is less potential for growth or larger payouts when opting for a fixed annuity.

Annuities that carry more risk but more potential for big payouts are known as variable annuities. When you purchase a variable annuity, your contributions are invested into various stocks and other investments.

When those investments perform well, you receive more money. When they don’t, you receive less. Variable annuities include a lot more risk for the simple reason that you can’t always predict how much value your annuity will have, and you will be more susceptible to feeling the impacts of a recession or down market.

Annuities also differ in when they are paid out. When you purchase an immediate annuity, you buy it with a lump sum and immediately begin receiving payments. This may potentially carry less risk in some circumstances since you know from the start exactly what the value of the annuity is.

Deferred annuities are paid into over time and build up a value. Since this value can be built up over many years, there can be some risk if your financial situation changes, and you are not able to contribute as much to the annuity as you planned for.

One potential important concern when purchasing an annuity is your access to the money you placed into it. There may be a penalty if you attempt to cash out the annuity or take out money that you have already placed within it

You also typically will not have access to the principal or money you put into the annuity once you begin receiving payments.

Say, for example, that you experience some kind of emergency or major expense several years into retirement. There may not be a way for you to cash out your annuity or access the lump sum to deal with that expense. Instead, you will be limited to the periodic payments.

According to the Federal Deposit Insurance Corporation (FDIC), annuities also lack the federal deposit insurance that bank accounts usually have. So, if the company that sold you the annuity goes bankrupt, there may simply be no way for you to get your money back. However, state guaranty associations can provide a safeguard.

It depends on the specific investment, but annuities can be safer or as safe as other typical retirement investments.

A fixed annuity, for example, can be a safer route to establish income for retirement than investing heavily in stocks, which come with more potential for losses and uncertainty.

Annuities also hold some benefits over an option such as an IRA. While both annuities and IRAs allow for contributions to be tax deferred, annuities typically don’t include contribution limits. This can allow you to potentially build up more savings faster.

But an annuity may carry more risk compared to an employer-sponsored plan such as a 401(k), especially since employers may match contributions.

It’s important to remember that annuities do not make sense for everyone. Whether using an annuity as part of your retirement strategy makes sense will depend on your personal goals and circumstances.

One of the main benefits of buying an annuity is the eventual access to a guaranteed stream of payments that provides an extra layer of security in retirement. These payments can last the rest of your life and ensure that, even if your main retirement savings vehicles run dry, that you will still have regular income. 

Another advantage of annuities is that your contributions are tax deferred, allowing you to potentially take advantage of a lower tax bracket and pay fewer taxes when you retire.

Plus, you can save as much as you want since there’s typically no contribution limit on an annuity.

One of the biggest cons of opting for an annuity is the potential of dying early and wasting a significant chunk of your savings. While annuities are a solid investment for those who experience long retirements, an early death could leave your beneficiaries without access to the leftover funds.

Another major con is the lack of federal insurance. If the company that provides your annuity goes bankrupt, there may be no way for you to recoup the money put into the annuity, especially funds over state guaranty association limits.

There are also limits on access to the money you have saved up in the annuity. Once it is annuitized and paying you regular payments, there may be no way to access the principal in a lump sum.

Writer Ashley Donohoe contributed to this article.