Ask Stacy: Should I buy an Annuity for Retirement Income?

Now that traditional pensions are fading into history, Americans are scrambling for a source of lifetime retirement income. New twists on an old investment — annuities — can sometimes fit the bill.

Here’s this week’s question:

I have a question regarding fixed annuities with an income rider. I’m looking to provide some future security for my wife (11 years younger than me), and I’m being told that these are guaranteed, can’t-lose, programs. I’m always concerned when anyone tells me something is a guaranteed. Are these annuities really can’t-lose investments? What’s the catch?
– John

I wrote about annuities a couple of years ago, but let’s go over them again, including the kind John is interested in, a fixed annuity with an income rider.

Investing with an insurance company

As you’ll soon see, there are various types of annuities. But they all have one thing in common: They’re offered by insurance companies.

Insurance companies offer advantages over bank accounts, mutual funds and other types of investments, because insurance companies are treated differently under the law.

The two chief advantages? Tax deferral and the ability to bypass probate.

  • Tax deferral. If you have an IRA or 401(k), you know you don’t pay income taxes on the earnings until you take them out. Annuities offer the same advantage. As long as you leave the earnings alone, you don’t pay taxes on them. As with a retirement account, however, if you take the money before age 59½, you’ll face a tax penalty.
  • Bypassing probate. When you set up an IRA or 401(k), you’re allowed to name a beneficiary. If you die, the beneficiary gets the money without the hassle and expense of probate. This, too, is true with an annuity, as well as with another common insurance product, life insurance.

So here are two reasons annuities are popular: They let you postpone a tax bill, and they allow you to leave money directly to your heirs.

Now, let’s explore various types of annuities.

Fixed annuities: Certificates of deposit from an insurance company instead of a bank

Back in my investment adviser days, I’d use the exact words in the heading above to explain single premium deferred annuities, also known as fixed annuities, to clients. Because when you boil it down, that’s what they are — insurance company CDs.

Like a certificate of deposit from a bank, when you take out a single premium deferred annuity, you agree to deposit a lump sum for a fixed amount of time, and the insurance company agrees to pay you a fixed amount of interest. Unlike a certificate of deposit from a bank, however, the annuity is guaranteed only by the insurance company. There’s no FDIC insurance. And, as I mentioned above, as long as you let the interest accumulate, you won’t pay taxes on it.

Immediate annuities: Deposit a lump sum, get monthly income

This is what many people think of when they hear the word “annuity.”

With an immediate annuity, you give the insurance company a lump sum of cash, and it pays you a monthly income. The income can be doled out in any number of ways. For example, it could last for a fixed number of years, or the rest of your life. Or it could last for the rest of your life, then your surviving spouse’s. It could last for life, but for a minimum of 10 years. There are any number of possibilities.Obviously, the amount you’ll get monthly will depend on how much you deposit, as well as the length of time you expect to receive it. But if you’re looking for a predictable income in your retirement years — a pension substitute — this is where you might find it.

Fixed annuities with an income rider

This is what John is asking about. Think of these as a hybrid between fixed and immediate annuities. As with a fixed annuity, you deposit a lump sum and let it accumulate. But as with an immediate annuity, it can also pay an income later.

This type of annuity could make sense for someone in John’s position, because he can deposit a lump sum now, let it accumulate, then convert it to a monthly income years from now that will offer his younger wife additional security.

Unfortunately, income riders aren’t free and are confusing. For example, income riders will offer a rate called the roll-up rate. This rate, often between 5 and 8 percent, applies only with the income portion of the annuity — not the lump-sum accumulation part. The rate will be guaranteed for a certain period of time, known as the rate guarantee period. Then there’s the actuarial payout rate, which describes the percentage that will be paid out depending on the person’s age at which the income is turned on.

Income riders come with fees attached, and rates and terms vary widely from company to company. Because these are complicated contracts, get the details before committing and not from a commissioned salesperson, rather from an objective expert (think fee-based financial planner or accountant).

There’s lots of information online about this type of annuity. One article I found helpful was this one from Marketwatch.

Variable annuities: mutual funds from an insurance company

A single premium deferred annuity is a CD clone. Its variable cousin is the insurance company clone of a mutual fund. Think of it as a mutual fund wrapped in an insurance contract.

Like many mutual funds, you’ll often have various fund options, including growth (stocks), income (bonds) and balanced (both stocks and bonds). You can switch among various options without tax implications as long as you don’t take the money out.

Variable annuities also offer something mutual funds don’t: a death benefit that guarantees that no matter how the funds perform, the beneficiary can’t receive less than the original investment.

Potential problems with annuities

Thus far, I’ve highlighted the advantages of annuities. Unfortunately, however, it’s not all wine and roses.In a CNNMoney article called “Immediate Annuities: When Guaranteed Income Is a Bad Bet.” The author suggests that an immediate annuity might not be ideal for some retirees because once invested, your money is tied up. There’s no unwinding the contract if a health care or other crisis creates a need for cash.

Another potential problem with virtually all kinds of annuities is excessive fees. And as with mutual funds, fees are often not apparent or disclosed. For example, single premium and variable annuities routinely have back-end surrender fees lasting up to a decade. Variable annuities often have annual management and other fees in excess of 2.5 percent, 10 times more than some low-cost mutual funds. There’s also a charge for the death benefit offered by variable annuities.

For more on variable annuities, check out the Financial Industry Regulatory Authority’s “Variable Annuities: Beyond the Hard Sell.”

Are annuities for you?

There are situations where annuities can fit into your financial plan. As with any investment, however, annuities aren’t all created equal, so comparison shopping is a must.

If you’re looking for an immediate annuity, or a fixed annuity with an income rider, compare monthly income and options. If you’re looking at fixed annuities, compare rates and surrender fees. With variable annuities, you’ll want to look at all the fees, plus the performance. And remember, guarantees are only as solid as the company making them.

Companies like Vanguard, known for low-fee mutual funds, also offer low-fee annuities. Another low-cost option is TIAA-CREF, although you’ll have to meet eligibility requirements; likewise with USAA.

Finally, as with all investments, the more a salesman is trying to jam something down your throat, the more cautious you should be. Avoid commission-based financial advisers. Rule of thumb: If you’re not paying them by the hour, you’re probably paying them in ways you’re not aware of.

Got a money-related question you’d like answered?

You can ask a question simply by hitting “reply” to our email newsletter. If you’re not subscribed, fix that right now by clicking here.

The questions I’m likeliest to answer are those that will interest other readers. In other words, don’t ask for super-specific advice that applies only to you. And if I don’t get to your question, promise not to hate me. I do my best, but I get a lot more questions than I have time to answer.

Got any words of wisdom you can offer for this week’s question? Share your knowledge and experiences on our Facebook page. And share this article with your Facebook network.

About me

I founded Money Talks News in 1991. I’ve earned a CPA (currently inactive), and have also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate. Got some time to kill? You can learn more about me here.

Got more money questions? Browse lots more Ask Stacy answers here.

Find the right financial adviser

Finding a financial adviser you can trust doesn't have to be hard. A great place to start is with SmartAsset's free financial adviser matching tool, which connects you with up to three qualified financial advisers in five minutes. Each adviser is vetted by SmartAsset and is legally required to act in your best interests.

If you're ready to be matched with local advisers who will help you reach your financial goals, get started now.

Read Next
These 5 Laptops Have the Best Battery Life
These 5 Laptops Have the Best Battery Life

Need a laptop that runs as long as you do? Check out these models.

This Is the Best Used Car You Can Buy
This Is the Best Used Car You Can Buy

This car combines reliability, safety and long-lasting value.

15 Purchases That Make Life Easier As You Age
15 Purchases That Make Life Easier As You Age

There are many products that can make getting older — or any time of life — a little easier.

15 Ways to Stretch Your Dollars in Retirement
15 Ways to Stretch Your Dollars in Retirement

Getting older presents new ways to save money. Study these strategies to make your golden years more golden.

21 Items to Cut From Your Budget That You Won’t Even Miss
21 Items to Cut From Your Budget That You Won’t Even Miss

Start off the new year by implementing these small-but-smart savings strategies. They’ll soon add up.

View this page without ads

Help us produce more money-saving articles and videos by subscribing to a membership.

Get Started

Most Popular
Will I Get My Ex-Husband’s Social Security When He Dies?
Will I Get My Ex-Husband’s Social Security When He Dies?

Two factors determine how much money is coming to you.

7 Ways to Boost Your Credit Score Fast
7 Ways to Boost Your Credit Score Fast

Your financial security might soon depend upon the strength of your credit score.

21 Things You Should Always Buy at a Dollar Store
21 Things You Should Always Buy at a Dollar Store

Dollar stores have great bargains on these familiar purchases. Yes, even pregnancy tests.

13 Brilliant Bulk-Buy Items on Amazon
13 Brilliant Bulk-Buy Items on Amazon

Every household should have these products on hand. Buying them in bulk on Amazon saves you cash.

6 Reasons I Will Never Trust Suze Orman
6 Reasons I Will Never Trust Suze Orman

Beware: The self-proclaimed personal finance expert has a track record that suggests more sizzle than steak.

This Type of Social Security Benefit Is Often Overlooked
This Type of Social Security Benefit Is Often Overlooked

The Social Security Administration is not helping certain people get money to which they are entitled, a report says.

Getting These 2 Shots Could Reduce Your Risk of Dementia
Getting These 2 Shots Could Reduce Your Risk of Dementia

These vaccines may lower the risk of Alzheimer’s disease by up to 40%.

9 Everyday Problems You Can Solve With Vaseline
9 Everyday Problems You Can Solve With Vaseline

Forget expensive specialty products. Good ol’ petroleum jelly can address many common annoyances.

America’s Most Reliable Appliance Brand Is a Surprise
America’s Most Reliable Appliance Brand Is a Surprise

Have you heard of this appliance manufacturer?

16 Amazon Purchases That We Are Loving Right Now
16 Amazon Purchases That We Are Loving Right Now

These practical products make everyday life a little easier.

19 Purchases That Buyers Almost Always Regret
19 Purchases That Buyers Almost Always Regret

Think twice before buying these things.

19 High-Paying Jobs You Can Get With a 2-Year Degree
19 High-Paying Jobs You Can Get With a 2-Year Degree

These jobs pay more than the typical job in the U.S. — and no bachelor’s degree is required.

7 Tips for Building an Emergency Stockpile
7 Tips for Building an Emergency Stockpile

A pandemic or natural disaster could leave you reliant on your existing food supply. Is your pantry prepared?

8 of the Worst Things to Buy at a Dollar Store
8 of the Worst Things to Buy at a Dollar Store

Not everything sold at dollar stores is a great bargain or a safe purchase. Here’s our list of products to avoid.

Homeowners Say These 2 Kitchen Appliance Brands Are Best
Homeowners Say These 2 Kitchen Appliance Brands Are Best

One brand takes five of the top honors, while another ranks highest in three categories.

41 Things You Should Never Buy
41 Things You Should Never Buy

Some purchases are just plain dumb. Give yourself — and your budget — a break. Don’t spend money on this stuff.

9 Indestructible Products That Are Worth the Price
9 Indestructible Products That Are Worth the Price

If you’re willing to pay a little more for these products, you may never have to shop for another again.

5 Ways to Get Amazon Prime for Free
5 Ways to Get Amazon Prime for Free

Hesitant to drop $119 a year on an Amazon Prime membership? Here’s how to get it for free.

5 Household Disinfectants That Can Destroy the Coronavirus
5 Household Disinfectants That Can Destroy the Coronavirus

You likely already have some of these products at home.

View More Articles

View this page without ads

Help us produce more money-saving articles and videos by subscribing to a membership.

Get Started

Add a Comment

Our Policy: We welcome relevant and respectful comments in order to foster healthy and informative discussions. All other comments may be removed. Comments with links are automatically held for moderation.