The Role of Annuities: A Cautious Look

When you start researching retirement income strategies, you will inevitably come across annuities. An annuity is a contract you buy from an insurance company. In its simplest form, you give the company a lump sum of money, and in return, they promise to pay you a regular income, often for the rest of your life.

The Good: Guaranteed Income for Life

The main appeal of an annuity is that it can eliminate longevity risk—the fear of outliving your money. A simple “single premium immediate annuity” (SPIA) is the most straightforward type. You give the insurer a premium, and they start sending you a check right away. It can feel a lot like buying your own private pension, which can be very comforting.

For someone who is worried about a market downturn or wants to ensure their essential bills are always covered, dedicating a portion of their savings to an annuity can be a sensible part of a larger plan. It adds another layer of guaranteed income to cover your foundational needs.

The Cautious: Fees, Complexity, and Surrender Charges

However, the world of annuities can be very complex and expensive. Many modern annuities come loaded with high fees, long and costly surrender periods (a time frame during which you’ll pay a steep penalty if you want your money back), and complicated features. It’s crucial to understand exactly what you are buying.

You may also see optional features called annuity riders. These are add-ons that provide extra benefits, like an income stream that increases with inflation or a guaranteed death benefit for your heirs. While these can be valuable, they always come at an additional cost, which reduces your payout or increases your fees. There is no free lunch.

Worked Mini-Example: A Simple Annuity Calculation

Let’s say John is 67 and wants more guaranteed income. He decides to use $100,000 of his IRA savings to buy a SPIA. Based on his age and current interest rates, the insurance company offers him a lifetime payout of $600 per month. This translates to $7,200 per year.

The trade-off is clear: John no longer has that $100,000 lump sum. He can’t invest it in the market or leave it to his children (unless he buys a specific rider for that). But in exchange, he has secured an extra $600 of income he can’t outlive. For him, this peace of mind is worth the trade. It’s a personal decision, not a one-size-fits-all solution.

If you consider an annuity, stick to simpler products from highly-rated insurance companies. Work with a trusted financial professional who can explain all the costs and conditions. The U.S. Securities and Exchange Commission offers unbiased information to help you at Investor.gov.