Table of Contents

The annuity market reached record-breaking sales in recent years, with Americans investing over $385 billion in these products in 2023 alone. As we move into 2026, more retirees and pre-retirees are exploring annuities as a solution to their biggest fear: outliving their money. But with complex features, varying fees, and numerous product types, understanding what you're buying is crucial before making this significant financial commitment.

What Are Annuities?

An annuity is fundamentally a contract with an insurance company where you make an investment now in exchange for a stream of payments later. Think of it as creating your own personal pension plan. You can fund an annuity with a lump sum or series of payments, and the insurance company promises to provide income for a specified period or for life.

The core appeal lies in transferring longevity risk: the risk of outliving your savings: from you to the insurance company. Through a process called longevity pooling, your money is combined with other annuitants' assets, allowing those who live longer to benefit from the assets of those with shorter lifespans.

image_1

Types of Annuities Explained

Fixed Annuities provide guaranteed returns and principal protection. Your money grows at a predetermined interest rate, typically ranging from 3-6% annually depending on current market conditions. You'll never lose money, but your growth potential is capped at the guaranteed rate.

Variable Annuities allow you to invest in sub-accounts similar to mutual funds, offering higher growth potential but also market risk. Your account value fluctuates with market performance, and you could lose money. These typically come with higher fees to compensate for the additional investment management.

Indexed Annuities offer a middle ground, linking returns to market indexes like the S&P 500 while providing principal protection. You participate in market gains up to a cap (often 6-8% annually) but won't lose money during market downturns.

Immediate Annuities begin paying income within a year of purchase, ideal for those needing income now. Deferred Annuities accumulate value for years before converting to income, better suited for younger investors building retirement assets.

Key Benefits That Drive Popularity

Guaranteed Lifetime Income

The primary advantage that draws people to annuities is the guarantee of income you can't outlive. With retirement planning becoming increasingly complex, this certainty provides invaluable peace of mind. Unlike 401(k) accounts or other investments where you're responsible for making withdrawals last, income annuities transfer this responsibility to the insurance company.

Tax-Deferred Growth

Annuities grow tax-deferred, meaning you don't pay taxes on investment gains until you withdraw money. This allows your savings to compound more efficiently than taxable accounts. For high-income earners who've maxed out other retirement accounts, annuities provide additional tax-advantaged saving opportunities.

Market Protection During Volatility

Fixed and indexed annuities create what financial planners call a "protected income layer" in your retirement portfolio. This means your essential expenses remain covered even during market downturns, helping you avoid panic decisions during volatile market periods. This protection becomes increasingly valuable as you age and have less time to recover from market losses.

Customization Options

Modern annuities offer extensive customization through various riders and options. You can choose:

  • Joint survivor benefits for married couples
  • Death benefits for beneficiaries
  • Guaranteed periods (ensuring payments for at least 10-20 years)
  • Cash refund options protecting your initial investment
  • Living benefits that increase payments over time

image_2

Potential Drawbacks to Consider

Irreversibility and Liquidity Constraints

Perhaps the most significant limitation is permanence. Once you annuitize (convert your account to income payments), you cannot change your decision. This locks in your strategy regardless of changed circumstances, health issues, or family needs.

Most annuities also impose surrender periods: typically 6-10 years: during which early withdrawals trigger substantial penalties, often 7-10% of the withdrawn amount. If you might need significant liquidity, annuities may not be appropriate.

Complexity and Fee Structure

Annuities rank among the most complex financial products available. Variable annuities, in particular, can have multiple layers of fees including:

  • Management fees (0.5-2.5% annually)
  • Insurance charges (0.5-1.5% annually)
  • Rider fees (0.25-1.0% annually for each rider)
  • Surrender charges for early withdrawal

These fees can significantly impact long-term returns, potentially reducing your wealth compared to lower-cost alternatives.

Limited Growth Potential

With fixed annuities, your growth is capped at the guaranteed rate. During periods of strong market performance, you miss out on higher returns available through direct stock or bond investments. This trade-off between safety and growth potential requires careful consideration based on your risk tolerance and income needs.

Critical Questions Before You Buy

What's Your Actual Income Gap?

Before considering annuities, calculate your true income needs. Add up guaranteed sources like Social Security and pensions, then determine how much additional income you need. Often, people overestimate their income requirements, leading to purchasing more annuity than necessary.

Can You Commit Long-Term?

Given the permanent nature of annuitization and surrender periods, ensure you're comfortable with this commitment. Consider your health, family obligations, and potential future needs that might require liquidity.

How Strong Is the Insurance Company?

Since annuity guarantees depend entirely on the insurance company's ability to pay, research the issuer's financial strength ratings from agencies like A.M. Best, Moody's, and Standard & Poor's. Choose companies with ratings of A or better to minimize counterparty risk.

What Riders Do You Actually Need?

Insurance companies offer numerous optional features, each with associated costs. Common riders include:

  • Guaranteed minimum withdrawal benefits
  • Long-term care coverage
  • Death benefit enhancements
  • Inflation protection

Evaluate each rider's cost against its benefit, and only purchase features you'll likely use.

image_3

2026 Market Context

The current environment presents both opportunities and challenges for annuity shoppers. Interest rates remain elevated compared to the past decade, making fixed annuities more attractive with guaranteed rates often exceeding 5% annually. However, this also means opportunity costs are higher: you might earn similar or better returns through less restrictive investments.

Record annuity sales reflect growing demand for financial security amid economic uncertainty. Many investors, particularly those nearing or in retirement, prioritize stability over growth potential. This shift represents a fundamental change from the growth-focused strategies of previous decades.

The sequence-of-returns risk: the danger of withdrawing money during market downturns early in retirement: has become a primary concern. Annuities address this risk by providing predictable income regardless of market conditions.

For those interested in learning more about current market conditions and investment strategies, our podcast at www.1715tcf.com regularly discusses these topics with expert insights.

Making the Right Decision for Your Situation

Annuities work best when they solve a specific problem: the need for guaranteed lifetime income. They're not suitable as general investment vehicles due to their complexity and fees. Consider annuities if you:

  • Lack sufficient guaranteed income from Social Security and pensions
  • Worry about outliving your money
  • Want protection from market volatility for essential expenses
  • Have maxed out other retirement accounts and seek additional tax deferral
  • Can commit to the product long-term without needing liquidity

Avoid annuities if you:

  • Need flexibility and liquidity in your investments
  • Are comfortable managing market risk
  • Have significant estate planning goals requiring asset preservation
  • Cannot afford the fees and opportunity costs

The decision ultimately depends on your unique circumstances, risk tolerance, and financial goals. At Davies Wealth Management, we help clients evaluate whether annuities fit their comprehensive financial plan, considering all alternatives and ensuring any annuity purchase serves a specific purpose in their retirement income strategy.

Before making any annuity purchase, consider consulting with a fee-only financial advisor who can provide objective guidance. Visit our comprehensive financial planning services to learn how we help clients make these important decisions.

Remember, the best annuity is one that matches your specific income needs and financial situation, not one that tries to serve multiple purposes. Take time to understand what you're buying, compare multiple options, and ensure it fits your overall retirement plan before signing any contracts.