In simple terms, an annuity is a contact between a person and a company. The person gives the company a sum of money, and in return is promised a monthly payout, generally for the rest of their life. There are many cases where annuities make sense for retirees or folks planning to retire soon. At the same time, there are risks and situations where annuities are the wrong choice.

You are very likely better off with no annuity as opposed to the wrong one. The first challenge is finding out whether an annuity could work for you.

In the old line of thinking, annuities were considered a product for anyone – essentially a way to purchase your own pension. As a result, many people wrongly placed their entire investment portfolios into annuities.

When you think about it, investing your whole portfolio into a single investment doesn’t make sense for any financial instrument. These investors put themselves at considerable risk by placing all of their eggs in a single basket. They were also often whacked with innumerable hidden fees on their life savings. Many saw their monthly income drop as the investment markets took a tumble.

Because of this situation, many states now regulate the percentage of annuities you can hold in your portfolio, and for good reason. If you’re thinking about putting annuities into your portfolio, first consider a limit on the total.

The second big consideration is whether you’re looking to invest or simply to secure cash flow. Although annuities are often sold as investments, they shouldn’t be thought of as an investment product. They’re an insurance product – a contract between a person and a company – and you should only buy them for the guarantees in the contract.

While an annuity may turn out to be a good investment, that’s not the right reason to buy one.

If you want an investment, the market is full of mutual funds, ETFs, stocks and other investments. Accessing the stock market through annuities is an expensive and roundabout method. Essentially, you’re paying a middleman, the insurance company, to invest in the stock market. It’s much simpler to just do it yourself. If you’d prefer not to, professional money managers typically charge lower fees than annuities.

If they’re not an investment, when do annuities make sense? We recommend a person buy an annuity for what it will do (contractual guarantees), and not what it might do (hypotheticals).

In too many cases, folks buy annuities thinking they have guaranteed income based on potential earnings in the future. If the income is based on a formula or index, the guarantee is only the method used for calculation. It does not mean your monthly checks will always be the same.

One member of the Money Forever team summed it up pretty well with a single question: “Have you ever heard of a hedge fund investing in an annuity?” No, I can’t say that I have. It’s absolutely amazing the sort of things they can make a buck on – from stocks and bonds to mortgage-backed securities and interest-rate swaps. And yet you won’t find annuities in their portfolios. If the smart money isn’t investing with annuities, maybe the average Joe should take the hint.

So if you’re looking at an annuity as an investment product then you should probably look elsewhere. However, if you’re looking for a steady payout during retirement—and you’re willing to read the fine print to understand exactly what’s being promised to you—then you might be a good candidate. To see if you are, I suggest you use “The 8 Point Guide” to see if an annuity might fit your circumstances. Click here to access the guide and my new, free report, Annuities De-Mystified: Three Simple Tools for Choosing the Right Annuity.

Dennis Miller is the author of “Retirement Reboot”, a book chronicling his own journey to save his retirement in a low yield, turbulent investing environment and providing readers with actionable ideas for getting their retirement finances back on track. He works with some of the country’s top investment managers, authors and analysts to tackle the financial challenges faced by today’s retirees. Working with analysts at Casey Research, Dennis created "Miller’s Money Forever," a newsletter that provides retirees, and those soon to be retired, with actionable recommendations on how to prepare and maintain a profitable retirement portfolio. Prior to retiring in 2008 Dennis ran a successful consulting business and authored several books on sales management. He was also a regular contributor to the American Management Association and an active international lecturer for 40 years. Find more of Dennis’ columns and latest special research reports at millersmoney.com or contact him at dennis@millersmoney.

Related Articles
  1. Budgeting

    5 Ways To Stretch Your Retirement Budget

    Living comfortably can be easy if you follow a simple plan.
  2. Retirement

    How To Buy Annuities (And When Not To)

    Annuities are complicated products that require some basic homework to be done before requesting quotes. Retirees will want to think about how they envisage their lifestyle and even their potential ...
  3. Retirement

    Introduction To Annuities

    Everything you need to know about annuities.
  4. Options & Futures

    Getting the Whole Story on Variable Annuities

    Variable annuities are another way to save money tax-deferred - but don't jump in blindly!
  5. Retirement

    Inflation-Protected Annuities: Part Of A Solid Financial Plan

    If you worry about inflation and longevity risks, this may be the investment for you.
  6. Retirement

    Saving Money With A Private Annuity Trust

    Learn about a strategy that could help you reduce taxes, diversify your portfolio and generate income.
  7. Investing

    Automating Your 401(k) is Easier Than You Think

    If you like automation, you should check out these features that many 401(k) plans offer.
  8. Retirement

    What's a Defined Contribution Plan?

    A defined contribution plan is a company retirement plan that specifies the amount of money contributed to it.
  9. Retirement

    Infographic: How Much Money Do You Need to Retire in Hawaii?

    In this infographic we break down cost of living in Honolulu, Hawaii in terms of taxes, rent, food and other expenses and offer comparison to the cost of living in New York, Los Angeles, San ...
  10. Term

    What are Pension Funds?

    A pension fund is a company-sponsored fund that provides income for employees in retirement.
RELATED TERMS
  1. Dynamic Updating

    A method of determining how much to withdraw from retirement ...
  2. Possibility Of Failure (POF) Rates

    The likelihood that a retiree will run out of money prematurely ...
  3. Safe Withdrawal Rate (SWR) Method

    A method to determine how much retirees can withdraw from their ...
  4. Qualified Longevity Annuity Contract

    A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity ...
  5. Mandatory Distribution

    The amount an individual must withdraw from certain types of ...
  6. Auto Enrollment Plan

    An employer’s decision to sign employees up to have a percentage ...
RELATED FAQS
  1. Are mutual funds considered retirement accounts?

    Unlike a 401(k) or Individual Retirement Account (IRA), mutual funds are not classified as retirement accounts. Employers ... Read Full Answer >>
  2. Can my IRA be garnished for child support?

    Though some states protect IRA savings from garnishment of any kind, most states lift this exemption in cases where the account ... Read Full Answer >>
  3. Can I use my IRA savings to start my own savings?

    While there is no legal reason why you cannot withdraw funds from your IRA to start a traditional savings account, it is ... Read Full Answer >>
  4. Can creditors garnish my IRA?

    Depending on the state where you live, your IRA may be garnished by a number of creditors. Unlike 401(k) plans or other qualified ... Read Full Answer >>
  5. Are spousal Social Security benefits taxable?

    Your spousal Social Security benefits may be taxable, depending on your total household income for the year. About one-third ... Read Full Answer >>
  6. What are the best ways to sell an annuity?

    The best ways to sell an annuity are to locate buyers from insurance agents or companies that specialize in connecting buyers ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!