Annuities can provide steady income for as long as you live, which is one reason a senior might purchase one. These contracts with insurance companies come in many different varieties, which can help address seniors’ specific financial needs. However, their variety and complexity can make annuities confusing compared to relatively straightforward investments such as mutual funds and certificates of deposit. Annuities also often feature high fees and may be energetically marketed by insurance agents who can earn generous commissions on annuity sales. If you’re considering looking into annuities, here are types you may want to consider. Any time you face a significant financial decision, consider discussing it with a financial advisor.
Annuity Basics
An annuity is a contract with an insurance company you can purchase with a single lump sum payment or a series of smaller payments. The contract requires the insurance company to send monthly checks to the purchaser, also called the annuitant. Payments can start immediately or several years from now. And they can last for a set number of years or, of special interest to seniors, for the remainder of your life.
Depending on the annuity, payments can continue going to a spouse after the annuitant’s death. Some annuities also have a death benefit, similar to life insurance, that gives a lump sum to beneficiaries such as children when the annuitant dies.
Annuities aim to solve a number of challenges facing seniors, including generating reliable income for life and taking care of loved ones. They offer payment flexibility so you can design your payments to match your lifestyle, and make changes when you need to.
There are no contribution limits on annuities as there are for tax-advantaged retirement accounts. You can’t deduct money used to buy an annuity from your current income, like you can with an IRA. But annuity earnings are not taxed until distributed to you. At that point, you owe taxes on those earnings at the same rates as ordinary income.
However, annuities have disadvantages as well as advantages. They often charge annual fees from 1-3% or more, higher than many investments. Annuities generally have sizable minimum investment amounts as well. These may be as low as $5,000 for an initial deposit, but it’s not unusual for someone to invest several hundred thousand dollars in an annuity. And once you put all that into an annuity, you may not be able to access the money in case of an emergency.
Types of Annuities
Seniors can choose from many kinds of annuities, some of which directly address common concerns while others are less useful. Understanding pros and cons of each can take time and attention. One important way they differ is when you can start getting payments. Your choices in that sense are between immediate and deferred annuities:
| Annuity type | Features | Pros | Cons |
| Immediate | Payments to you begin within a year. | Supplemental income starting soon and continuing as long as you live. | No growth. It takes a lot of upfront money to fund. |
| Deferred | Payments start at a preset date in the future. | Funds in the account can grow tax-deferred. | Not helpful if you need immediate income. Lengthy lock-up period during which you may not be able to withdraw funds in an emergency. |
Annuities also vary in the way they are invested. There are three main kinds: fixed, variable and indexed.
| Annuity type | Features | Pros | Cons |
| Fixed | Minimum interest rate set for one to 10 years. | Stable supplemental income from predictable payments. | Lower investment returns than other types of annuities. |
| Variable | Payouts based on performance of stocks, bonds and other securities. | Potentially higher rate of return. | Exposure to market risk means potential for lower returns. |
| Indexed | Minimum guaranteed rate plus possibility of higher returns based on performance of an index. | Potential for higher earnings if index does well. | Caps limit the amount of added performance. |
Seniors may also want to consider annuities with riders (policy add-ons) that offer a long-term care insurance benefit. This can help pay for any expenses related to a stay in a skilled nursing home or assisted living facility as well as the cost for a home health aide or other extended care. However, having an annuity may make you ineligible to receive help from Medicaid while not providing enough to pay for all long-term care expenses. Â
One limitation of most annuities is that the payments, while reliable and predictable, are not adjusted for inflation like Social Security benefits. Over time, this can erode your purchasing power. Inflation-protected annuities counter this problem with an annual cost-of-living adjustment. The downside here is that inflation-protected annuities generally offer lower payouts to begin with, so it may take many years of inflation for it to make financial sense.
Bottom Line
Much like Social Security, annuities can help you in your senior years by providing regular, reliable and predictable payments. Some annuities are insulated from market risk, and different varieties can provide continuing payments to a spouse or death benefits to beneficiaries after you die. Annuities typically have high fees compared to many investments and most are not adjusted for inflation like Social Security. An annuity can be part of many seniors’ portfolios, but it takes care and caution to understand what you’re buying before putting down a large sum of money for one.
Tips for Retirement Planning
- Before purchasing an annuity, sit down to talk it over with a financial advisor. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- It’s important to consider inflation when planning your retirement. Use SmartAsset’s inflation calculator to get an idea of the impact of inflation over time.
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