Who Should Not Buy an Annuity?

When you start to think about planning for retirement, your mind may instinctively go to investments. While traditional investments can be an incredibly effective means of growing your wealth to prepare for retirement, they’re far from your only options. Another option you might consider is an annuity.

Below, we take a closer look at what an annuity is, how it can work in conjunction with other retirement options, and who should, or should not, buy an annuity.

Annuity basics

An annuity is  an insurance product that’s meant to help you create reliable retirement income that lasts as long as you live.  It is a contract between you and an insurance company.

Some annuities can help you accumulate funds for retirement, while others are purchased closer to retirement and are only meant to help you generate income.

Income annuities vs. accumulation annuities

There are several types of annuities for you to consider. They typically fall into one of two categories:

1. An income annuity is designed to provide you with a steady source of guaranteed income that continues for your lifetime. Immediate income annuities begin making regular payments to you shortly after you get one. Deferred income annuities start paying you at a later date with payments, typically starting 13 months or more after you purchase the annuity.
    
2. An accumulation annuity is designed to help you save for retirement. As the name suggests, they accumulate value over time. In the future, typically in retirement, you can decide to either convert your savings into an income stream and receive payments for the rest of your life or take the value of your annuity as a lump sum. Fixed annuities and variable annuities are two common types of accumulation annuities.

The benefits of annuities

The primary benefit of annuities is that they offer financial security by providing you with a guaranteed source of income that you can’t outlive. Some people think of it as a “paycheck for retirement.” When combined with a range of other financial options for retirement, an annuity can help to strengthen your overall retirement plan. 

With non-variable income annuities, payments are unaffected by the stock market, and all annuities help protect you financially in case you live a very long life.

Who should not buy an annuity?

While an annuity can help strengthen most retirement plans, there are some cases—particularly when it comes to income annuities—where an annuity might not make the most financial sense.

If you are in poor health

With income annuities, there are ways to guarantee that payouts will last for a certain amount of time for beneficiaries if you die too soon. However, if you are in poor health, it’s possible that there may be better options for your situation than an income annuity.

If you have adequate guaranteed income sources

If you’re lucky enough to have a pension that (along with Social Security) will cover your need for guaranteed income that you can’t outlive in retirement, then you may be better served to deploy your other financial resources elsewhere. A Northwestern Mutual financial advisor can work with you to help you find the right mix of financial products that can help you best achieve your goals in retirement.

If you don’t have adequate liquid savings

Annuities work best when you use a portion of your savings to purchase the guaranteed income an annuity can provide. If, however, buying an annuity would leave you without enough savings to cover unexpected expenses, then an annuity may not be the right choice for you.

If you’re working on short-term savings goals

When it comes to annuities that help you accumulate funds for retirement, if you have short-term savings goals like buying a car or a home, you should make sure your other goals are met before funding an accumulation annuity. That said, it’s important to make sure you’re balancing your needs for today with long-term goals like retirement.

Like any financial decision, it’s important to do some research and talk with a professional—like a Northwestern Mutual financial advisor. They can help you assess market conditions like the prevailing economic and interest rate environment before making a significant financial commitment.

Other financial products to consider

Annuities may not be the best fit for everyone, but thankfully, there are many different financial products to consider:

Bonds

These relatively safe investments can provide a stable income stream with lower risk than stocks¹. Interest income from bonds is generally taxable at the federal level, but some bonds, such as municipal bonds, may also provide tax advantages.

Certificates of Deposit (CDs)

These products usually have fixed terms ranging from a few months to several years, during which funds are “locked in.” If you try to access the funds during that time, you’ll likely owe a penalty. CDs are insured by the Federal Deposit Insurance Corporation for up to $250,000 per depositor and account type, per insured bank.

Mutual funds

Mutual funds are a popular way to invest in securities with the advantages of diversification and professional management. Target-date funds are a type of mutual fund that can be helpful in retirement income planning. These funds automatically adjust their asset allocation based on your planned retirement year (or another goal date)². The funds automatically become more conservative as the target date approaches. The investment is subject to market fluctuations and can still incur losses, particularly during economic downturns.

Permanent life insurance

This financial product provides a death benefit to your designated beneficiaries when you die. In addition, over time it accumulates cash value that you can access for any reason, and you may receive dividends based on the company's performance.³

Stocks

Stocks are a key component of almost every diversified portfolio. Due to the potential for volatility, it’s best to count on them for long-term growth. This allows you to ride out market downturns and benefit from compounding returns. Dividend-paying stocks—which are offered by a company that may distribute a portion of its profits to shareholder—are an option that can provide income even in a fluctuating market.

Additional considerations when buying an annuity

As you think about how an annuity could help, it’s also important to know the financial strength of the company offering it. You can do this by looking into ratings given by independent agencies such as A.M. Best Company.

Also keep in mind that while annuities grow on a tax-deferred basis, the distributions you would eventually receive from an annuity may be subject to ordinary income tax. Typically, if you withdraw money from your annuity before you turn age 59½, the IRS treats it as an “early” or “premature” distribution. In that case you may owe a 10 percent penalty on the taxable portion of the withdrawal. Consult an independent tax advisor to help understand tax implications.

Like all financial products, annuities do come with some costs. Pay attention to fee structures and understand how they will impact you. Common fees include surrender charges, administrative fees, mortality and expense charges, and investment management fees. Also consider the commission and the sales charge when calculating the cost of any annuity.  At the end of the day, annuities are still more affordable than many people think.

When considering an annuity, the answer may involve more than a simple “yes” or “no.” It’s often a good strategy to purchase multiple financial products such as a CD and an annuity as part of a diversified portfolio. People saving for retirement might allocate a portion of their savings to a CD for short-term priorities and invest the rest in an annuity for long-term growth and potential tax advantages.

Should you buy an annuity?

An annuity can be a great way to reliably generate some income in retirement; however, there are times when it might not make sense. Whether or not you should buy an annuity will largely depend on your financial goals and your broader plan for retirement, including other sources of retirement income.  A Northwestern Mutual financial advisor can help you take a look at your big financial picture and help develop a plan that suits your situation. Our plans include a range of financial options—including annuities—to help you achieve your goals.

Guarantees in an annuity are backed solely by the claims-paying ability of the issuer.  For variable annuities, guarantees do not apply to the investment accounts which are subject to market risk, including loss of principal.  Income annuities have no cash value. Once issued, this annuity cannot be terminated (surrendered), and the premium paid for the annuity is not refundable and cannot be withdrawn. 

¹You should carefully consider risks with fixed income securities such as bonds, these include:  Interest rate, Duration, Credit, Default, Liquidity and Inflation. Interest rates and bond prices tend to move in opposite directions, for example when interest rates fall, bond prices typically rise.   This also holds true for bond mutual funds.  High yield (Junk) bonds and bond funds that invest in high yield bonds present greater credit risk than investment grade bonds.

²All investments carry some level of risk, including loss of principal invested. No investment strategy can guarantee a profit or protect against a loss. The target date is the appropriate date when investors plan to start withdrawing the money. The principal value, including at the target date, is not guaranteed. 

³Dividends are not guaranteed. The primary purpose of permanent life insurance is to provide a death benefit. Using permanent life insurance accumulated value to supplement retirement income will reduce the death benefit and may affect other aspects of the policy.