Annuities

Why it matters in retirement

Annuities can solve a real retirement problem: longevity risk (outliving your money). But they're also one of the highest-commission products in financial services, and the wrong annuity at the wrong time locks up capital you can't get back. Know the difference between the four main types.

A Deeper Look

An annuity is a contract between you and an insurance company. You give the insurer a sum of money, and in return, the insurer promises to pay you income, either immediately or at some point in the future. The insurance company pools your premium with those of thousands of other annuity holders and uses actuarial math to guarantee payouts. People who die early effectively subsidize those who live longer, which is how the insurer can promise income for life without knowing exactly when any individual will die. This risk pooling is the fundamental value proposition, and it is something no investment portfolio can replicate on its own.

There are four main types of annuities, and they differ enormously in cost, complexity, and usefulness. A Single Premium Immediate Annuity (SPIA) is the simplest. You hand over a lump sum and begin receiving monthly payments right away, usually for life. In 2026, a 65 year old male can expect roughly $6,500 per year for every $100,000 invested. A $300,000 SPIA would generate approximately $19,500 per year, guaranteed for life, regardless of market conditions. SPIAs have minimal fees because the insurer's profit is built into the payout rate, and they solve the specific problem of longevity risk in the most direct way possible.

A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity purchased with IRA or 401(k) funds that begins paying at a future age, typically 80 or 85. The 2026 maximum premium is $210,000. Because payments are deferred, the payout rates are much higher than a SPIA. A QLAC purchased at 65 that begins paying at 85 might pay $25,000 to $30,000 per year for every $100,000 invested. QLACs also reduce your required minimum distributions because the amount in the QLAC is excluded from the RMD calculation until payments begin. For retirees worried about outliving their money in their 80s and 90s, a QLAC is one of the most efficient tools available.

Variable annuities are where the industry's reputation problems begin. A variable annuity is essentially a tax deferred investment account wrapped inside an insurance contract, with optional guaranteed income riders attached. The underlying investments are mutual fund like "subaccounts" that rise and fall with the market. The all in cost typically runs 2% to 3.5% per year, layering a mortality and expense charge (1.0% to 1.5%), subaccount management fees (0.5% to 1.0%), and an optional guaranteed income rider (0.5% to 1.25%). These fees compound relentlessly and are almost impossible for the investment returns to overcome. Variable annuities also carry surrender charges of 5% to 8% if you withdraw within the first 5 to 10 years. The commissions paid to the selling agent, often 5% to 7% of the premium, explain why variable annuities are so aggressively marketed despite being inferior to simpler alternatives for most buyers.

Fixed indexed annuities (FIAs) credit interest based on the performance of a market index, typically the S&P 500, but with caps, participation rates, and spreads that limit your actual return. An FIA might offer "participation in 50% of S&P 500 returns, capped at 8%." If the S&P 500 returns 20% in a year, you earn 8% (the cap). If it returns 5%, you earn 2.5% (50% participation). If it goes negative, you earn 0% (the floor). This sounds appealing, but when you run the numbers over long periods, the effective annual return on most FIAs has been 3% to 5%, which is comparable to what you could earn in a simple bond portfolio without the complexity, surrender charges, or illiquidity.

When evaluating annuities for your retirement plan, start by identifying the specific problem you are trying to solve. If you want guaranteed lifetime income to cover essential expenses, a SPIA or QLAC is the right tool, and you should get quotes from at least three highly rated insurance carriers (A.M. Best rating of A or better). If you want tax deferred growth, max out your IRA and 401(k) first, as they offer the same deferral without the high fees. If someone is proposing a variable or indexed annuity, ask for the total annual cost including all riders and subaccount fees, the surrender schedule, and what the guaranteed income base actually promises versus the account value. In most cases, a combination of a SPIA for guaranteed income and a low cost index fund portfolio for growth and flexibility will outperform any variable or indexed annuity, and it will cost a fraction of the fees.

Common mistakes

• Buying a variable annuity inside an IRA (tax deferral is wasted)
• Confusing an indexed annuity with actual stock market returns
• Not comparing SPIA payouts across multiple carriers
• Annuitizing 100% of assets and losing flexibility