What Is the Primary Reason for Buying an Annuity?

Annuities are insurance products that provide owners with a contractually guaranteed stream of income, either immediately or in the future. Some types of annuities offer fixed or variable accumulation benefits before the contracts are converted into an income stream. The main benefits of annuities include tax-deferred growth, guaranteed payments over a lifetime or a specified period and potential death benefits for heirs.

Annuities come in many variations and offer numerous contract riders that can provide additional guarantees or customizations. Unlike many purely market-based retirement vehicles, such as IRAs or 401(k)s, annuities can be tailored to the specific needs of the owner.

The primary reason investors purchase annuities is to secure guaranteed lifetime income that will not deplete, regardless of how long they live. As an insurance product, income annuities benefit from the collective premiums of thousands of investors, which the insurance carrier uses to provide guarantees that offset certain unknown future risks. Unlike life insurance—typically used to mitigate the risk of premature death—annuities are designed to protect against the risk of longevity, which could otherwise deplete one’s retirement savings.

One of the biggest unknowns in retirement planning is the length of retirement. If we knew exactly how long we would live, retirement planning would be a straightforward budgeting exercise.
In reality, there are many factors to consider when planning for the unknown length of time we might live and the uncertain expenses we will incur along the way. Annuities, along with other sources of guaranteed income such as Social Security and pensions, provide much-needed income reliability and offer a counterbalance to fluctuating withdrawals from an invested portfolio.

The traditional “three-legged stool” of retirement—consisting of Social Security, a pension and personal savings—has become less relevant due to the decline in pension availability.

Today, this concept can be repurposed into a new three-legged stool:

While annuities are primarily used to guarantee income, they offer a range of benefits through various contract types and use cases, such as tax deferral, limiting market risk and creating a guaranteed inheritance.

Annuities offer two unique features that other retirement vehicles do not: nearly unlimited contributions and tax deferral. Unlike IRAs or 401(k)s, annuities are not subject to IRS contribution limits, though insurance carriers may impose their own internal limits.

For high-income investors, annuities can provide a way to shield additional savings from taxable investment income once other tax-deferral options have been exhausted. Multi-year guaranteed annuities (MYGAs) serve as a viable alternative to CDs, typically offering both tax deferral and higher interest rates. Investment-only variable annuities can also help boost retirement savings when other contribution limits have been reached.

The fluctuations of the stock and bond markets can make many pre-retirees uneasy. Annuities offer options to limit or eliminate the downside risk of these markets while still allowing for some potential upside. Products like fixed index annuities or registered index-linked annuities (also known as structured annuities) provide peace of mind by protecting your money from downturns during the critical years leading into retirement.

Many investors worry that annuities aren’t worth it if they end when the owner dies. However, this concern only applies to contracts structured in that way. It’s easy to add specific riders to annuities that ensure a guaranteed return for a specified period or provide a guaranteed death benefit to heirs.

Adding riders such as period certain or cash refund to an income annuity ensures that, regardless of how long the owner lives, a specified amount of money will be paid out of the contract—either to the owner or to the heirs. Death benefit riders can also be added to variable or fixed index annuities to guarantee a minimum amount for beneficiaries, regardless of the investment performance of the annuity.

Additionally, sophisticated estate planning strategies can combine trust accounts, annuities and life insurance to provide various benefits to heirs. If you are interested in maximizing death benefits for your heirs, consult with an estate attorney or financial advisor who specializes in these areas.

Annuities provide stress-free retirement income for life, but they also offer additional benefits when used as saving and accumulation vehicles. Retirement planning involves more than just the numbers in your financial accounts; it requires balancing your emotional need for safety with your financial need for growth to achieve a happier and healthier financial plan.

For personalized advice on creating a retirement income plan tailored to your specific needs, work with a financial advisor. Begin by understanding your needs and goals, and then align solutions to meet those goals. Remember, no two retirement plans are identical because no two individuals are exactly the same.