Annuities occupy an uncomfortable middle ground in retirement planning. They are neither universally terrible nor universally excellent. The real question for any investor is whether a specific annuity fits their particular situation.
An annuity is a contract you purchase from an insurance company. You pay a lump sum or make regular payments. In return, the insurer guarantees you income for a set period or for life. This certainty appeals to retirees worried about outliving their savings.
The appeal is straightforward. If you live to 95 and your portfolio runs dry at 90, an annuity bridges that gap with guaranteed payments. Social Security handles some of this need, but many people want additional guaranteed income. That is where annuities enter the picture.
The costs are real. Annuities often carry high fees, sometimes 1 to 3 percent annually. Surrender charges apply if you need your money early. The complexity varies wildly. Simple immediate annuities tend to cost less and work transparently. Variable annuities with riders for income guarantees become byzantine quickly.
Liquidity matters too. Once you hand over your money, accessing it becomes difficult and expensive. Your heirs may receive less than you contributed. This trade-off between security and flexibility troubles many investors.
The appropriate candidate for an annuity typically has several characteristics. They have already maxed out retirement accounts like 401(k)s and IRAs. They need guaranteed income beyond Social Security. They can afford to lock away a portion of savings. They have a long life expectancy. They are not comfortable managing their own investments.
A 68-year-old with a pension, Social Security, and a modest nest egg probably does not need an annuity. A 72-year-old with only Social Security and fear about market risk might benefit from converting a portion of savings into guaranteed income