Making sure you have enough money for retirement requires getting strategic. There are a lot of moving parts: what you have saved in retirement accounts, how much you’ll be able to collect from Social Security or a pension, other investments you hold, and the various sources of income you could tap after you’re done receiving a steady paycheck.

One potential piece to this puzzle: annuities. So what are annuities? They’re contracts between you and an insurance company, in which you pay the company regular payments or a lump-sum payment in return for payments back to you over time. They are typically used to provide a reliable stream of income for retirement.

Annuities can provide you with cash either immediately or in the future, but it’s important to know the pros and cons of annuities before deciding whether they make sense for your situation. We’ve outlined just a few below to help you get started.

THE PROS

Annuities provide certainty. When you live off your savings, you take the risk that you could live too long or lose money in the market and eventually run out of money. Annuities help protect against that by providing guaranteed payments either for a set amount of time or for the rest of your life — no matter how long you live.

You have options depending on your timeline. If you’re on the verge of retiring or already retired, immediate income annuities start making payments back to you soon after you make a lump-sum payment to the insurance company. If retirement is still years away, you could opt for a deferred annuity. In that case, you make a lump-sum payment and then that money grows tax-deferred until you’re ready to annuitize — that is, convert the deferred annuity into regular income payments.

You have options depending on your comfort with risk. Deferred annuities can be either fixed or variable. The money inside a fixed annuity grows at a fixed interest rate, which means you’re guaranteed the same monthly payment amount when your annuity starts making payments. But if you’re good with taking on more risk, you could opt for a variable annuity, which invests your money in investment options also known as subaccounts. If the subaccounts perform well, when you annuitize you may wind up with better payments. But just like with other investments, if your subaccounts perform poorly (perhaps even decline in value) your payments could be lower when you start receiving income.

You can use qualified and non-qualified dollars. Qualified and non-qualified refer to the way money you earn in a given year is treated from a tax perspective. Qualified dollars “qualify” for special tax treatment, so those contributions are considered pre-tax (like the contributions you make into a 401(k) or an IRA). Non-qualified money refers to dollars you’ve already paid income tax on, so they are considered post-tax.

You can put both qualified and non-qualified dollars into an annuity. If you’re using non-qualified dollars, there is no contribution limit. If you’re purchasing an annuity with qualified dollars, you’ll be subject to an IRS limit on your contributions.

Your money grows tax-deferred. It doesn’t matter if your contributions were qualified or non-qualified, your money will grow tax-deferred. Once you start taking payments from a qualified annuity, your payments will be taxed as ordinary income (you didn’t originally pay tax and now the government wants its share). With a non-qualified annuity, you will be taxed on the gain but not the amount you paid in (the government already taxed you on that). Also note that similar to retirement accounts, if you withdraw too early (before age 59½) you may be subject to an additional 10 percent federal tax penalty — on top of any ordinary income tax you may owe or charges you may have to pay per your annuity contract.

THE CONS

Higher fees than some other types of retirement investments. Generally, when compared with fees you pay for mutual funds, index funds or other investments, some annuities charge high fees and commissions. Examples of annuity fees include a mortality and expense risk charge — usually a percentage of your account value — which is paid to the insurance company for the insurance risk it takes on in an annuity contract. And if you withdraw early from a deferred annuity (usually in the first six to eight years), you may have to pay a penalty called a surrender charge. Carefully read your annuity contract to understand all the fees you could be paying as they could eat into your returns.

Annuities can provide you with cash either immediately or in the future.

It can be hard to change your mind about an immediate income annuity. Many immediate income annuities are irrevocable, which means you can’t take your money back after you purchase them. That’s why it’s important you know the terms of your contract before you decide if a particular annuity is the right source of income for you.

You may have to pay a surrender charge to transfer your annuity. If you decide you want to switch your annuity to another company to lower the fees you pay, it may not be worth it if you have to pay a surrender charge to the original company. You’ll also have to keep in mind the strength of the company you choose to buy your annuity from, since they have to be able to fulfill any of the guarantees they promise in the annuity contract.

Not all annuities provide a death benefit. With a 401(k) or IRA, you’ll always have the ability to designate a beneficiary to receive your money after you die. Once an annuity is paying out, your beneficiaries may or may not get anything once you die. Some annuities offer guaranteed payouts for a certain number of years even if you die. Others offer the ability to continue paying out for a second person — usually your spouse, although these options may come at an additional cost. But it’s a good idea to read your contract closely so that you know what happens if you die soon after you start taking payments.


Guarantees in an annuity are backed solely by the claims-paying ability of the issuer.

The performance of variable funds and underlying investment options are not guaranteed and are subject to market risk, including loss of principal.

Withdrawals from annuities may be subject to ordinary income tax, a 10% IRS penalty if taken before age 59½, and contractual withdrawal charges.

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