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What is an annuity investment?

An annuity investment is an amount of money you put into an insurance product, with the expectation that you will receive a payout later. In general, you have two options with annuities:

  1. You can choose to put money into an annuity over time, for a period of years, during the growth phase.
  2. You can decide to make one big lump sum to purchase an annuity and receive an immediate payout.

For the most part, your annuity is supported by underlying investments. When you make an annuity investment, your money is put into different funds, which depends on the type of annuity you have.

The insurance company usually decides how to invest your money when you buy a fixed annuity. It most often chooses relatively safe funds and assets. The company wants a predictable rate of return, even if the payout is low.

On the other hand, when you choose a variable annuity or some other type of annuity that allows access to other investments, your money might be kept in different assets. For example, you may be able to choose from a variety of mutual funds for a portion of your annuity investment. The long-term results of your payout would be based, in part, on the performance of the underlying assets you chose for your annuity.

Keep this in mind and understand the risks involved when deciding on an annuity investment. If your investments do poorly, your payout won't be as big. Your payout could fluctuate, depending on the terms of your annuity. It's vital you understand this before you decide whether an annuity is a right move for you.

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How do annuities work?

During the growth phase of the annuity, you put money into it. The idea is to grow your money to a level that allows it to sustain payouts. After you meet the terms of the growth phase, you switch to the payout phase. This is when you begin receiving payments from the annuity.

At first glance, it may seem that annuities are a good investment. You put money in, and the insurance company selling the product guarantees an outcome. However, the type of payout you get depends on what you put into it, along with other factors.

Some of the factors that influence your annuity investment outcome include:

  • How much you pay into the annuity during the growth phase
  • The size of the payout you want
  • Whether your payouts are for a set period of time or spread over the remainder of your lifetime
  • Whether your annuity is fixed or based on underlying investments

When are annuities a good investment, and when are they not?

The question, “Are annuities a good investment?” depends largely on your long-term personal goals, especially as they relate to retirement.

Annuities can offer a set amount of income during retirement. Some investors want this. It's possible to use an annuity to at least meet your basic needs. And then you can use other types of investments to help you meet other goals. You don't need to base your entire retirement income on an annuity.

As long as you understand the fees and terms of the annuity, an annuity can be a good investment. Just make sure it fits into your overall financial plan.

On the other hand, an annuity investment may not be a good choice if, for example, if it has many fees or complicated restrictions. Some annuities are designed to be straightforward. But others are so convoluted you're not sure what you're getting into.

Additionally, don't buy an annuity from someone who isn't looking at your finances holistically. Be sure they can clearly explain where and how an annuity fits in with your goals.

As with most investments, it's usually not a good idea to put all of your eggs in one basket. An annuity investment is the same. While an annuity could make a reasonable addition to your financial plan, it shouldn't be your entire plan. Want to create a good financial plan? Paladin Registry can match you up with financial advisors who will help you achieve your goals.

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Annuities: pros and cons

Before deciding if you should move forward, make sure you understand annuity pros and cons. Here's what to consider:


  • Guaranteed income: An annuity offers a certain amount of guaranteed income. That way, you don't have to worry about other factors that could impact your income. This includes the possibility of a minimum level of income payments designed to ensure that you at least have your basic needs met.
  • Assistance with money management: Depending on the situation, you might have access to someone to help you manage your money. They could help you with automatic rebalancing and figuring out how to incorporate your annuity into the rest of your finances.
  • Survivor benefits: It's possible to customize your annuity to include a death benefit or to ensure that your payouts are transferred to a spouse after you pass on.
  • Tax-deferred: You aren't taxed on money you put into your annuity. Your contributions are made with pre-tax dollars. Additionally, there are no income restrictions and contribution limits with annuities. However, you are taxed on the payouts once you begin receiving them.


  • High fees and commissions: Many annuity investments come with high fees and commissions. Those selling the annuity might get a kickback, which could mean they steer you into something that isn't best for you. On top of that, there could be high fees for annual maintenance. Additionally, even with a death benefit, there could be charges associated with it that can reduce what gets passed on to your heirs.
  • Surrender costs: If you need your money sooner, you could end up paying a steep cost, known as a “surrender charge.”
  • Early withdrawal penalty: Understand that your annuity investment could come with an early withdrawal penalty from the IRS. If you start taking money before you reach age 59 and-a-half-years old, you could end up paying a 10% early withdrawal penalty on top of paying your regular tax.

Annuity types

There are different annuities to consider. Each has its benefits and drawbacks, so it's important to understand how they work and how each type could fit into your retirement planning goals. Here are some of the main annuity types you're likely to encounter:

1. Immediate vs. deferred annuities

Depending on your situation, it might make sense to take a portion of your retirement savings and purchase an immediate annuity that guarantees a base level of income for the remainder of your life. The rest of your nest egg can remain in the appropriate tax-advantaged account. This provides you with extras and helps you maintain your desired lifestyle or meet other goals.

Immediate annuities

An immediate annuity is one that begins offering payouts as soon as you fund it. You fund this type of annuity using a lump sum. You could fund it from another retirement account when you're ready to retire. An immediate annuity can be structured to offer payments for a set period of time or for life.


  • The ability to lock in a fixed income stream for your lifetime or a set number of years, depending upon your choice.
  • Immediate annuities often provide a better return than safer instruments like CDs and money market accounts.


  • Fixed immediate annuity payments can be eroded by inflation over time. Some contracts may offer an inflation rider, but there is a cost to this protection.
  • Payments for a variable immediate annuity can vary over time and could be subject to the performance of the underlying investments.

Deferred annuities

Rather than beginning payouts at once, the annuity grows over time. The growth phase can be as little as seven years or as long as 30 years. Basically, you put in a set amount each month (or add lump sums). The money grows over time. When you're ready to take payouts, the amount in the account (among other factors) determines how much you receive. The other factors include whether you want a payout for a set amount of time or the rest of your life.


  • You can postpone taking the earnings or interest income and paying taxes on it.


  • The returns on a fixed deferred annuity may not always be as high as other safe investment alternatives. You should make a full comparison before committing your money here.
  • The tax-deferral aspect of a fixed variable annuity may not be advantageous if you find yourself in a higher tax bracket in retirement as many do these days.

2. Fixed annuities

These annuities offer a fixed payout, based on how much you put in and whether you have an immediate annuity or a deferred annuity. With a deferred annuity, the provider offers a plan that results in a set payout. The amount depends on how much you contribute each month and how long you make those contributions.

Fixed annuities provide a degree of stability and predictability. They could work well if you know how much you need for the basics and then use other investments and sources of income for the rest of your retirement needs.


  • They pay a fixed rate of interest.
  • Most have low minimum investments.
  • The deferral of taxes until annuitization or withdrawal.


  • Sometimes the rate is fixed for only a certain period of time; the rate can then drop after this “teaser” period.
  • When you annuitize, the payments are generally not indexed for inflation.

3. Variable annuities

Variable annuities (VAs) are invested in sub-accounts that are much like mutual funds. The amount available for distributions depends on the amount that you paid and how well the underlying investments have done.

Variable annuity sub-accounts are offered in a variety of asset classes such as stocks, bonds, cash-like options, and other sub-asset classes. Many popular mutual funds offer a VA version as well. Be aware, though, that even though these sub-accounts may sound like a popular mutual fund, they are different. They have a separate portfolio that may or may not be identical to the mutual fund’s holdings. Additionally, the sub-account will often carry the higher fees of the annuity contract.

Money contributed to a variable annuity grows tax-deferred until either withdrawn or annuitized. (“Annuitizing” involves converting the total investment into the periodic payments you will receive.) VAs can be a good addition to your retirement savings efforts. But for most people, a 401(k) or IRA should be fully funded before going down this route.


  • Another vehicle for tax-deferred investment growth.


  • Many VAs are layered with fees.
  • Sub-accounts are often inferior to their mutual fund “cousins.”
  • All annuities can be problematic when it comes to estate planning.

4. Indexed annuities

If you're looking for a hybrid between a variable and fixed annuity, an indexed annuity could be an appropriate choice. With an indexed annuity, a portion of your investments are pegged to specific equity indexes. However, some of your money is also guaranteed with less-risky assets. So, you're promised a base income, which limits your losses. But you also reap some benefits of good market performance.

It's important to understand that your gains are limited, along with your losses. You won't get the full benefit of good market returns, but you also have more limits to your downside, which could make up for it.


  • In the opinion of this writer, none.


  • Limited upside participation in the underlying index.
  • Complex structure with hidden fees and expenses.
  • Some carry hefty surrender charges.

5. Longevity annuities

These products are designed for those who end up living longer than expected. In general, you can't start receiving a payout until you reach age 80. Additionally, a longevity annuity usually pays out for the rest of your life and has a guaranteed fixed payout.

With this type of annuity, you put some of your money into the annuity, with the knowledge that it will sit there and act as a sort of supplement if you end up living a long time. It can help you with basic living expenses and provide you with security later in life. However, you should understand that most of these annuities won't go to your heirs, so if you die before you begin receiving payouts, that money is just gone.


  • Provides a backstop against running out of money later in retirement.
  • Can have the same impact as buying a much larger immediate annuity.


  • If you die before payouts begin, all of the money is lost to the insurance company.

Hefty fees and expenses

One of the disadvantages of many annuities is their high fees and expenses. The details on these fees and expenses are nearly impossible to find within the documentation provided.

It is not uncommon to see annuities with internal expenses exceeding 2%–3%. Also, many contracts have steep surrender charges that kick in if you try to remove funds from the contract prior to a set date.

Mortality and Expense (M&E) fees are the charges by the insurance company to cover the costs of the insurance guarantees and the administrative expenses of selling and servicing the annuity. These charges are built into the contract and deplete the underlying returns and value of your account.

Surrender charges are used by insurance companies to limit withdrawals from the account during the early years of ownership. A contract might carry a surrender charge of 8% for the first few years that then gradually decreases over time. A contract might have a surrender period of eight, 10 or more years. I’ve seen some as high as 15 years.

Using 8% and a $100,000 balance, this equates to an $8,000 surrender charge if you tried to withdraw your balance. This applies even when you roll it over to an annuity at another company. These charges can be significant. So be sure to find out all of the details before writing a check.

Investment management fees are the fees charged to oversee your investments. These fees are rarely as low as those on an equivalent mutual fund. Often the M&E charges are hidden as part of the subaccount expense ratios.

Do annuities make sense for retirement savers?

The answer, of course, is “it depends.” Annuities have both pros and cons. Some pros and cons are related to annuities in general. Some are specific to the contract you might be looking at. It is often said annuities are sold, not bought. This means too many annuity purchases are made as the result of aggressive sales tactics.

There is much disagreement among financial advisors as to the wisdom of holding an annuity in an employer retirement account such as a 401(k) or 403(b), or in an IRA. There is no added benefit, as the distributions will be fully taxable upon distribution unless some of the contributions were made with after-tax dollars. Some say the ability to annuitize is the benefit. You need to weigh the costs of the annuity to determine if this benefit is truly worth the costs.

Options for beneficiaries

Annuities have a beneficiary feature. For spouses, a continuation of the payments can be an option, though there are others. The options for non-spousal beneficiaries can be complex. The rules for a trust being a beneficiary are complex as well. Before buying a commercial annuity, you need to understand what happens to the contract upon your death and decide if this fits with your plans.

Annuities are just one of many investment options

There is no one right answer to the question, “Are annuities good investments?” Instead, whether an annuity makes sense in your financial plan depends on your individual situation and goals, as well as what type of annuity you get.

Before making your choice, consult with a trusted financial professional — preferably one who doesn't have a conflict of interest based on what annuity you choose. Review the terms and fees and understand what you're getting before you move forward. Fisher Investments and their 15-Minute Retirement Plan may be a good option for such an advisor.

Some people find that an annuity investment works well as part of a broader retirement plan. Others decide that it's best to avoid annuities in their planning.


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Miranda Marquit Freelance Contributor

Miranda Marquit is a journalism-trained freelance writer and professional blogger specializing in personal finance.


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