The sales pitch is almost irresistible: Hand over a lump sum and you will get a monthly check for life. After decades of saving, that guarantee can sound like a simple solution for retirement. What the pitch often leaves out is how much you have to give up in exchange.
What an Annuity Actually Gives You
When you buy an annuity, you pay an insurance company a lump sum in exchange for regular payments. And, depending on the type of contract, those payments may continue for the rest of your life.
The appeal usually is not a bigger return. It is turning part of your savings into income that keeps coming no matter how long you live. For retirees worried about outliving their money, certainty can be the main reason to consider an annuity. But that promise comes at a cost.
The Downsides Nobody Talks About
The promise of lifetime income comes with conditions that deserve just as much attention as the monthly check:
- The biggest is liquidity: Once you hand over a lump sum to buy an annuity, you generally lose the flexibility to access that money. If your plans change or you face an unexpected expense, withdrawing money early may trigger surrender charges or other penalties. And in some cases, you may not be able to access the full amount at all.
- Cost is another consideration: Depending on the product, an annuity may include administrative fees, rider charges, investment expenses and sales commissions that reduce what you ultimately receive. Those costs are not always obvious when you buy the contract, but they can add up over time.
- Inflation is another factor that’s easy to overlook: Unless your annuity includes inflation protection, a fixed monthly payment buys less over time as the cost of living goes up. Your income stays the same even though your expenses may not.
None of these factors automatically make an annuity a poor choice. But they can change whether it’s the right choice for you. A financial advisor could help you compare an annuity with other retirement income strategies and decide if the guaranteed income is worth the costs and restrictions.
When an Annuity May Be Worth Paying For
An annuity can make sense if your biggest concern is creating income that lasts a lifetime. It may also be a good fit if you already have enough liquid savings for emergencies and won’t need easy access to the money you invest.
You may, however, consider another option if you need easy access to your money, already have enough guaranteed income from sources such as Social Security or a pension, or want to prioritize long-term growth.
An annuity may seem like the safest choice, but it’s not always the best one. A financial advisor can help you compare an annuity with other retirement income strategies and decide whether this insurance product is the right fit for your retirement plan.
Photo credit: ©iStock.com/Milan Markovic, ©iStock.com/Drazen
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