Are Annuities a Safe Retirement Investment?
Annuities can be a safe and effective retirement investment, helping to guarantee a stream of income in your golden years. But like with any financial product, there are risks to consider that can vary depending on the type of annuity you are interested in. Annuities don’t make sense for everyone, and it’s important to evaluate your circumstances before deciding.
- Written by Christian Simmons
Christian Simmons is a writer for RetireGuide and a member of the Association for Financial Counseling & Planning Education (AFCPE®). He covers Medicare and important retirement topics. Christian is a former winner of a Florida Society of News Editors journalism contest and has written professionally since 2016.Read More
- Edited ByLamia Chowdhury
Lamia Chowdhury is a financial content editor for RetireGuide and has over three years of marketing experience in the finance industry. She has written copy for both digital and print pieces ranging from blogs, radio scripts and search ads to billboards, brochures, mailers and more.Read More
- Financially Reviewed ByToby Walters, CFA®
Toby Walters, CFA®
Chartered Financial Analyst and Paraplanner
Toby Walters, CFA®, has over 25 years of financial research experience. With a knowledge and understanding of researching and analyzing financial data, he has developed a unique and experienced viewpoint on money matters. He has been a chartered financial analyst since 2003, and most recently a portfolio analyst and paraplanner.Read More
- Published: March 16, 2023
- Updated: April 28, 2023
- 9 min read time
- This page features 2 Cited Research ArticlesKey Takeaways
- Annuities can be both a safe and effective investment for retirees, guaranteeing an additional income stream in retirement.
- Annuity payments can last the rest of your life, meaning purchasing an annuity can help ensure you never run out of money in retirement, even if you exhaust your main savings.
- Annuities do carry some risk, including the fact that they are not FDIC-insured. It can also be difficult, or even impossible, to access the principal once your annuity begins paying out.
Are Annuities Safe for Retirees?
Annuities can be a safe and strong investment for retirees as long as the retiree understands the risks associated and selects the proper type of annuity for their personal situation.
When you purchase an annuity, you typically pay into it over time or deposit a lump sum into it all at once. In exchange, you eventually receive a guaranteed stream of payments that can last the rest of your life.
Annuities can be attractive to retirees because it can help ensure they don’t run out of money in retirement. Even if your main savings like a 401(k) or IRA are exhausted, the payments from an annuity will continue as long as you are alive.
It may make sense for some people to use annuities as part of their retirement plan if they have the resources to do so. It can be a great way to supplement a retiree’s main savings and Social Security payments with an additional income stream.
An added benefit is that annuities are tax deferred and typically don’t include a contribution limit.
But like with most types of financial products and investments, there are risks attached that are important for individuals who are interested in buying an annuity to understand.Although investments generally reward risk with higher returns, your goal in retirement is geared more to preserving your assets. Annuities can play an effective role during this period. Annuities can lower risk by diversifying your investment portfolio. For example, fixed index and immediate annuities are paid by the issuer and not directly affected by the stock market’s performance.
What Makes Annuities Risky During Retirement
There are several factors that can make it risky to invest in an annuity as part of your retirement strategy.
One risk is the possibility of dying before you recoup or exceed the value of the annuity. The great benefit of purchasing an annuity is the fact that its eventual payments will last for the rest of your life, even if those payments exceed the principal.
But if you die early into retirement, then the annuity may be a poor investment since you put a lot of money into a product that you weren’t able to maximize.
For this reason, annuities may not always make sense for those with serious health problems or who don’t expect to have a long lifespan.
Annuity Safety and Risk Level by Type
The potential risks involved with purchasing an annuity will vary depending on the type you are interested in. Some styles carry more inherent risk than others.
One type that comes with a lower level of risk but also lower reward is a fixed annuity. According to FINRA, in a fixed annuity, you are locked into a set interest rate and set payouts.
This allows you to know exactly how much money you will be receiving from your annuity without having to worry about dramatic fluctuations. The tradeoff is that there is less potential for growth or larger payouts when opting for a fixed annuity.
Annuities that carry more risk but more potential for big payouts are known as variable annuities. When you purchase a variable annuity, your contributions are invested into various stocks and other investments.
When those investments perform well, you receive more money. When they don’t, you receive less. Variable annuities include a lot more risk for the simple reason that you can’t always predict how much value your annuity will have, and you will be more susceptible to feeling the impacts of a recession or down market.
Annuities also differ in when they are paid out. When you purchase an immediate annuity, you buy it with a lump sum and immediately begin receiving payments. This may potentially carry less risk in some circumstances since you know from the start exactly what the value of the annuity is.
Deferred annuities are paid into over time and build up a value. Since this value can be built up over many years, there can be some risk if your financial situation changes, and you are not able to contribute as much to the annuity as you planned for.STEP 1STEP 2STEP 3
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What Risks Come with Annuities
There are risks to be aware of when considering buying an annuity. One potential concern is your access to the money you placed into the annuity. There may be a penalty if you attempt to cash out the annuity or take out money that you have already placed within it.Did You Know?It can be difficult, or even impossible, to cash out an annuity once it is annuitized and you begin receiving payments.
You also typically will not have access to the principal or money you put into the annuity once you begin receiving payments.
Say, for example, that you experience some kind of emergency or major expense several years into retirement. There may not be a way for you to cash out your annuity or access the lump sum to deal with that expense. Instead, you will be limited to the periodic payments.
Another risk to be aware of when buying an annuity is that they are not FDIC-insured. This means that if the company that sold you the annuity goes bankrupt, there may simply be no way for you to get your money back.
Many annuity providers are major companies, but this risk makes it important to be certain that you are dealing with a legitimate partner and reputable company when purchasing an annuity.Advertisement
Are Annuities Safer Than Other Investments
It depends on the specific investment, but annuities can be safer or as safe as other typical retirement investments.
A fixed annuity, for example, can be a safer route to establish income for retirement than investing heavily in stocks, which come with more potential for losses and uncertainty.
Annuities also hold some benefits over an option such as an IRA. While both annuities and IRAs allow for contributions to be tax deferred, annuities typically don’t include contribution limits. This can allow you to potentially build up more savings faster.
But an annuity may carry more risk compared to an employer-sponsored plan such as a 401(k), especially since employers may match contributions.
Pros and Cons of Annuities for Retirees
It’s important to remember that annuities do not make sense for everyone. Whether using an annuity as part of your retirement strategy makes sense will depend on your personal goals and circumstances.
One of the main benefits of buying an annuity is the eventual access to a guaranteed stream of payments. These payments can last the rest of your life and ensure that, even if your main retirement savings vehicles run dry, that you will still have regular income.
Annuities provide an extra layer of security to retirement.
Other advantages of annuities include the fact that your contributions are tax deferred, allowing you to potentially take advantage of a lower tax bracket and pay fewer taxes when you retire.
There is also typically no contribution limit on an annuity, allowing you to save up as much money as you want.
While annuities have many benefits, there are drawbacks to be aware of as well. One of the biggest cons of opting for an annuity is the potential of dying early and wasting a significant chunk of your savings.
Annuities are a solid investment for those who experience long retirements since the payments last your entire life. But there is always the risk of an early death, in which case, your beneficiaries may not have access to the leftover funds in your annuity.
Another major con to be aware of when buying an annuity is the lack of federal insurance. If the company that provides your annuity goes bankrupt, then there may be no way for you to recoup the money you put into the annuity.
There are also limits on access to the money you have saved up in the annuity. Once it is annuitized and paying you regular payments, there may be no way to access the principal in a lump sum.Enjoy a Safe & Secure RetirementLearn how annuities provide premium protection, guaranteed retirement income and long-term care benefits through our partner Annuity.org.
Annuity Safety and Risk FAQsDo recessions affect annuity payouts?Recessions can affect annuity payouts depending on the type of annuity. Variable annuities, for example, are invested into stocks, bonds and other investments. So, if those investments are affected negatively by a recession, that could be represented in the annuity’s payouts.Are annuities insured by the FDIC?Annuities are not insured by the FDIC. For this reason, it is important to be certain that you are dealing with a reputable and established provider when buying an annuity.How do annuities help optimize Social Security benefits?Annuities can optimize Social Security benefits by adding an additional stream of income to your retirement. With both annuity and Social Security payments, you can be set financially even after your main retirement funds are exhausted.Advertisement
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2 Cited Research Articles
- Wisconsin Office of the Commissioner of Insurance. (2018, February). Consumer’s Guide to Understanding Annuities. Retrieved from https://oci.wi.gov/Documents/Consumers/PI-214.pdf
- Financial Industry Regulatory Authority. (n.d.). Annuities. Retrieved from https://www.finra.org/investors/investing/investment-products/annuities#risks
- Edited By
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