If you decide an annuity may be appropriate for your needs, first realize that typical commissions for a sales person average around 7%, meaning that selling a $100,000 annuity results in an upfront commission of $7,000. That’s like walking in the door with $100,000 and writing out a check to the salesperson for $7,000. Therefore it’s critical that you find a financial professional you have considerable confidence in, meaning a person you believe will act in your best interests when discussing the various types of annuities available to you for purchase, and whether an annuity is the best option for you in the first place relative to your total financial situation.

What is an annuity? 

An annuity can be thought of as buying insurance to protect against outliving your financial assets. No retiree wants to confront being unable to meet living expenses sometime in the future.

Where should I start?

You should begin by categorizing your assets into three buckets: your stable and consistent income base (Social Security, pensions if you have one), your total investments and variable return from these investments, and your emergency fund.

If your income base is sufficient to meet your recurring expenses and your emergency fund is adequate to meet unanticipated future expenses, then you can focus on whether you want to convert some or all of your liquid investments to one or more annuities.

Note that when you consider your entire financial circumstances as an integrated whole made up of the three buckets, your current objectives for your investments could change.

For example, if you bought an annuity to meet your present and expected future basic living expenses, you could consider raising the investment risk on your remaining investment assets and then characterizing this bucket as a “growth” portfolio as contrasted with an “income” portfolio. That could be beneficial should you live longer than you planned for.

Why might I want to convert some or all of my liquid investments to an annuity? 

For two reasons: emotional – I want to stop worrying about fluctuations in their values, and financial – I believe a large, highly-rated insurance company is likely to do a better job than I or my investment advisor has done in the past. 

Are there good alternatives for annuities that could also meet my objectives? 

There may be: laddered strategies with CDs, Treasury bonds, or other highly rated bonds or bond funds.

Note the income from these types of investments is 100% income as contrasted with annuities that return a combination of income and capital (your original capital).

If I decide to purchase an annuity, what should I pay attention to? 

First make sure you have clearly defined your objectives for purchasing one. Include in these whether you have a legacy goal to pass money to heirs or to charities. If there is any foreseeable reason that you might need access to these funds in the future, be able to explain why you are willing to tie up your liquid assets in an annuity.

What is your inflation expectation for the future, and for how many years do you expect this to potentially impact your future expenses? Will you require an annuity with a fixed COLA, or a variable COLA tied to an index?

What are your assumptions in terms of living to what age? This is important as it will change fairly dramatically the amount required upfront for purchase.

For example, if you are in your 80s and start looking at estimates you may find the return is much higher than you expected. There is a simple reason for this: the insurance company is betting that you will not live longer than they plan for, meaning  they will get to keep most of your money.

What are the ongoing fees and surrender charges? These can be substantial depending on the type of annuity.

Are there commutation options? Commutation options allow policyholders access to funds in the annuity in the event of unexpected need. This can be a valuable option depending on how you have allocated your total assets.

How will the income be taxed? Will some of the monthly income be treated as income and some as return of capital? How will this affect your tax planning for your financial assets in total?

An example of a basic, straightforward annuity  – SPIA – Single Premium Immediate Annuity 

Pros: longevity insurance at a reasonable cost, protection against cognitive decline, and no annual fees. Note this does not mean there are no fees, only that the fees are included in the upfront purchase price you are quoted.

Cons: lack of liquidity (depending on commutation options), inflation risk, and risk of insurer default.

An example of a type of annuity to avoid: index annuities.

Where can I go to find good online resources to help with my research? 

To get cost estimates of annuities: https://ImmediateAnnuities.com.

For asset allocations, life expectancy data, and computing fair SPIA prices:  https://AACalc.com.

This site can be a bit daunting, but it has lots of good information and analyses and will be worth your time and effort if you can deal with detail.

My bottom line on annuities

Be able to explain to anyone your reasons for purchasing one. Keep your reasoning simple and explainable in your own words.  If you can’t explain your reasons for purchasing one, don’t do it.

Make sure you have evaluated alternatives before making any decision. Whenever I have an important decision to make given several options, I always ask what it would take to undo a decision that turned out not to have been the best one. Undoing the purchase of an annuity will be costly.

Evaluate annuities as part of your total retirement plan by assessing what role they could play. For example, if you have a need for a specific amount of fixed income but also want to keep investment growth as another important goal, you could put some of your retirement funds in an annuity and invest the rest in stocks.

Annuities should never be considered in isolation, they should serve as one option in meeting your overall financial needs.

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