How Annuities Fit in Your Financial Plan: An Honest Take From A CFP®
Did you know that the average retiree will spend over 20 years in retirement, but most people have no guaranteed income beyond Social Security? That's a recipe for sleepless nights and constant worry about running out of money due to market fluctuations.
Annuities Then & Now
If you're in your fifties, sixties, or seventies, you've probably heard horror stories about annuities. Maybe your uncle got stuck in a high-fee product that barely grew and he couldn't get out of it, or you've read articles claiming they're financial products nobody should buy.
Luckily, the annuity landscape has changed dramatically, and when used correctly, they can solve some very real retirement fears.
The challenge is most people either love annuities or hate them with very little middle ground. Today I want to give you the truth about where they actually fit in a well-designed financial plan.
Understanding Annuities
An annuity is basically a contract with an insurance company where you trade a lump sum of money for guaranteed payments either now or in the future. Think of it as creating your own personal pension.
Annuities fall into three categories:
Fixed annuities that guarantee a specific return
Variable annuities where your return depends on underlying investment performance
Indexed annuities that give you market upside with downside protection
When Annuities Make Sense
Here are specific situations where I would suggest annuities to clients:
The Annuity Rescue
If you already own an older annuity that's costing you too much or doesn't fit your needs anymore, we can use a 1035 exchange to move that money into a more suitable modern product without tax consequences. I often see people stuck in products with 3% annual fees when they could be in something much cleaner and less costly.
Market Pessimism with Growth Desire
If you lived through 2008 and 2020 and the thought of another market crash keeps you up at night, some indexed annuities today let you participate in market gains while protecting your downside.
Supplementing Stable Income
Having predictable income each month makes retirement budgeting much easier. It's a structured approach to expense planning and directly addresses longevity risk. Which is running out of money before you die.
The Behavioral Benefit
Knowing that income will hit your account on the same day every month can help you make better decisions in other parts of your financial life. Less stress, more confidence, better sleep.
Who Should Avoid Annuities
Annuities don't fix everyone's needs. Here's who should avoid them:
If you're under 55, forget about them. You still have plenty of time to recover from market crashes. Limiting your gains or locking up assets doesn't make sense when you're still working with reliable income.
Also avoid them if you need liquidity, don't have an emergency fund yet, or haven't maxed out your 401(k) and IRA contributions. Remember: annuities are meant for guaranteed income to cover essential expenses. They're not for maximizing returns, but for minimizing financial insecurity in retirement.
The Real Advantages
The biggest advantage is downside protection. In some products, you can invest in the S&P 500 through an indexed annuity and never lose a penny, even in a market crash.
A recent game-changer has been fee-based annuities. There's been a major shift toward fiduciary service as clients recognize that many advisors of the past, and even many today, were just selling products that paid them the highest commission.
Fee-based annuities can remove surrender charges and other fees that used to trap people for decades, meaning you're not locked into a product that might grow out of your needs over time.
The Honest Downsides
Annuities have a dark past, and I won't sugar-coat it. They were sold by predatory salespeople who took advantage of elderly and uneducated investors, sticking them in high-fee, high-risk products that got crushed in 2008.
Even today, there are no guarantees beyond the insurance company's ability to pay. Always check the company's financial rating. Think of it as a credit rating for bonds.
Annuities are terrible for leaving money to heirs. If they're funded with after-tax dollars (non-qualified money), they don't get a stepped-up basis that regular investments do when the owner dies. Your heirs will pay taxes on the full growth, while brokerage investments get a stepped-up basis and pay zero taxes on that growth.
That's why I typically only recommend annuities inside retirement accounts where everything gets taxed as ordinary income anyway.
What is a MYGA?
A Multi-Year Guaranteed Annuity (MYGA) is like the CD of the annuity world. You get a guaranteed interest rate for a specific period, usually three to ten years, and you can lock in current attractive rates for longer terms that can beat most CDs while providing tax-deferred growth.
At the end of the term, you can renew, move the money elsewhere, or cash out penalty-free. It's the simplest, most straightforward annuity option for most people looking for income.
Getting Organized!
If you're ready to organize your finances for a confident retirement, I've created a free Financial Plan Organizer that walks you through every step. It includes sections specifically for evaluating annuities and mapping your income strategy.
Business owners or pre-retirees! If you want personalized help with these decisions from a fiduciary advisor serving clients nationwide from Charlotte, NC, this is exactly what I help people with every day.
The key is making sure you absolutely need an annuity before committing to a product that could lock up your money for a long period. Annuities can play a role, but exhaust all other options first.
Use the button below to request your FREE Financial Plan Organizer!
Frequently Asked Questions About Annuities:
How do annuities fit into retirement planning?
Annuities can provide guaranteed, predictable income that supplements Social Security and helps manage longevity and sequence of returns risk, making retirement budgeting much easier. They're designed to create your own personal pension and address the fear of running out of money in a 20+ year retirement.
Who should consider buying an annuity?
Pre-retirees over 55 who want to stabilize income, protect against market downturns, or upgrade old high-fee annuities through a 1035 exchange should consider annuities as part of a diversified retirement income plan.
What is a 1035 exchange and when should I use it?
A 1035 exchange allows you to transfer funds from an existing annuity to a new one without tax penalties. This is useful for moving out of outdated, high-fee products into modern, more flexible fee-based annuities that offer better transparency and lower costs.
What are the main types of annuities and how do they differ?
Fixed annuities offer guaranteed returns with a specific rate
Variable annuities depend on underlying investment performance
Indexed annuities provide market upside with downside protection
Your choice depends on your risk tolerance and income needs.
What are the advantages of fee-based annuities?
Fee-based annuities can remove surrender charges and hidden fees that used to trap people for decades, improve transparency and flexibility, and align better with fiduciary planning principles. They clearly define the risks you take and benefits you receive, making them more client-friendly than legacy products.
Why should I be cautious about non-qualified annuities for estate planning?
Non-qualified annuities don't get a stepped-up cost basis at death, meaning heirs may owe taxes on all growth. For example, if you buy a $1 million annuity that grows to $2 million, your heirs pay taxes on the full $1 million of growth, while taxable brokerage accounts get stepped-up basis and pay zero taxes on that growth.
What is a MYGA and why is it considered a practical option?
A Multi-Year Guaranteed Annuity (MYGA) works like the CD of the annuity world, offering a fixed interest rate over a term (usually 3-10 years), tax-deferred growth, and penalty-free options at the end of the term. It's the simplest, most straightforward annuity option for most people looking for predictable income.
When should I avoid annuities?
Avoid annuities if you are under 55 or far from retirement, need liquidity, lack an emergency fund, or haven't maxed out tax-advantaged retirement accounts like 401(k)s and IRAs. Annuities are designed to cover essential expenses and minimize financial insecurity, not maximize returns. Exhaust all other options before committing to products that lock up your money.
Use the button below to request your FREE Financial Plan Organizer!
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The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
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