Those who are retired or expect to retire soon need a retirement plan in place to ensure their basic expenses are covered in retirement. That's one reason why annuities have soared in popularity. In fact, they are so attractive to investors that total annuity sales were $113.5 billion in the first quarter of 2024. That's 21% above prior year results and just shy of the quarterly sales record set in the fourth quarter 2023, according to preliminary results from LIMRA’s U.S. Individual Annuity Sales Survey,
While annuities are enjoying a surge of popularity, the concept of annuities dates back to early Rome, when citizens would make a lump-sum payment on a contract called an annua in exchange for income payments received once a year for the rest of their lives.
Modern-day annuities are more complicated than that, and even though they’ve kept the name, they’re not for everyone. Before considering an annuity, there are some basics you should know, including what annuities are, what options they provide and how safe your money will be if investing in an annuity.
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Here are a 10 things you should know about annuities before you invest.
1. What are annuities?
An annuity is an insurance contract where you, the purchaser, pay an insurance company to invest your money, allowing it to grow tax deferred. In some instances, the annuity later provides a stream of income, according to the contract provisions, which could cover a set length of time or until you die.
In this sense, annuities are insurance against outliving your savings because they can make payments for as long as the contract requires, even if the underlying principal and any earnings have been depleted.
If you have a lifetime annuity and live a long life, you could receive a total far more than the amount you originally invested. However, depending on the terms of the annuity, it’s also possible that you might die before recouping your investment.
2. Should you add a rider to an annuity?
Annuities are classified in several different ways, including how they are purchased and how the funds grow. They can also be customized with different contract provisions known as riders. For example, an annuity could include a long-term care rider that increases your payout should you require long-term care. Or a rider could provide for funds from an annuity to go to a beneficiary should the annuity holder die before receiving the funds.
You should keep in mind that these riders cost money, meaning if your annuity pays you a regular monthly, quarterly or annual income, the income payments will be smaller. In other instances, an annuity may pay a lump sum at a specified date.
3. Annuities vs CDs: which pay more?
Annuity shoppers may be seeking the security of a certificate of deposit (CD), but with a better return. For now, annuities are delivering that.
Annuities: Total fixed-rate deferred annuity (FRD) sales totaled $83.1 billion in the first half of 2024, up 15% from the same period last year, according to LIMRA.
Fixed indexed annuity (FIA) sales totaled $58.3 billion in the first half of this year, up 20% year over year. Traditional variable annuity sales also improved in the first half, up 12% at $29.3 billion.
“This time last year, LIMRA reported a record-shattering second quarter and first half of the year. Those results wane in comparison to this year’s results,” said Bryan Hodgens, senior vice president and head of research in a LIMRA press release. “Annuities have benefited from the favorable economic conditions and the Federal Reserve not cutting interest rates this year. We also believe demographic trends and a growing awareness of unique value proposition annuities offer have shifted the U.S. annuity market post pandemic, resulting in 15 consecutive quarters of strong sales growth.”
Certificates of Deposit: After rising for the past couple of years, CD rates have flattened out and will likely see a decline by the end of the year. Since they tend to follow the federal funds rate, as the Fed rate rises, to do CD rates. Even so, national average CD rates are higher than in past few years, with the average 12-month CD earning 1.85% as of July 2024, according to FDIC data. Keep in mind that some high-yield savings accounts are paying out upwards of 4%, as demonstrated in many of the offers below.
4. Immediate annuities vs. deferred annuities: what's the difference?
When it comes to how they are purchased, there are two types of annuities: immediate annuities and deferred annuities. Immediate annuities will begin paying a stream of income within a year of their purchase. They are best for retirees who want to receive payouts right away.
Deferred annuities are better for people who are still saving for a future retirement. The money they invest grows tax-deferred until it is withdrawn later.
A deferred annuity requires a smaller outlay of cash. You can also add to it before the payout. With this annuity, you get guaranteed payments or a lump sum when you reach a certain age. You might also elect to roll your deferred annuity over into another deferred annuity that pays out at a later time.
5. How do annuities grow your money?
Beyond the distinction of when annuities start paying (immediate vs deferred), annuities also offer a range of options in how and what they pay out. They can help grow your retirement savings, even if you’ve maxed out contributions for the year to qualified plans such as IRAs and 401(k)s. Plus, unlike these plans, they aren’t subject to annual IRS contribution limits.
Different annuities grow at different rates:
- If your contract calls for a fixed-rate annuity, the funds will grow at a fixed rate of interest for a period of years specified in the contract. When the term is up, that rate can reset for the next period.
- Variable annuities allow you to invest your money in mutual-fund-like subaccounts, so the payout will follow the performance of the portfolios.
- Indexed annuities have their rate of growth tied to an index, such as the S&P 500.
6. Annuity payouts: single life vs. joint life
If you buy an immediate annuity, you’ll get the highest annual payout if you buy a single-life version — one that stops payouts when you die, even if your spouse is still alive. The payment amount is determined by several factors, including the initial lump sum payment, the annuitant's age, life expectancy, and the prevailing interest rates in the market.
But if your spouse is counting on that income, it may be better to take a lower payout that will continue for his or her lifetime, too. (Some annuities are guaranteed to pay for a certain number of years, even if you and your spouse die during that period.)
Joint life annuities are designed for retired couples who want a guaranteed monthly income that will continue for as long as either spouse lives. Payments are usually slightly lower, but they last longer.
7. Annuity payouts: men vs. women
In general, if you have an annuity that pays income for life, the longer your life expectancy, the smaller your payments will be.
Consequently, the older you are when your annuity starts sending you payments, the higher your payments will be because your life expectancy is shorter. For this reason, some people ladder their annuities — investing some money early in retirement to cover expenses, then adding more when they get older to boost payouts. Plus, laddering can allow you to take advantage of rising interest rates: Each new contract will have the latest rate.
This is also why men receive higher payments from their life income annuities because men usually have a shorter life expectancy than women and, on average, will receive fewer payments.
8. You'll pay fees for cashing out your annuity early
Although deferred annuities let you cash out at any time, you may not get all your money back. You generally have to pay a surrender charge that starts at about 7% to 10% of the account balance in the first year, and gradually decreases every year until it disappears after seven to ten years. Also, if you take the money before age 59½, you generally have to pay an early-withdrawal penalty.
9. Your annuity is protected even if the insurer goes bankrupt
It’s important that you purchase your annuity from an insurance company that is financially secure. Annuities are not regulated or insured by the federal government — but as an insurance product, are overseen by states. If you have a fixed deferred annuity or are receiving fixed immediate annuity payouts, then your payouts are protected by your state guaranty association. The level of protection varies by state. Find your state limits at the website of the National Organization of Life & Health Insurance Guaranty Associations.
10. You could buy an annuity within a 401(k)
A growing number of companies are giving employees the option of investing in an annuity in their 401(k) plans that can be converted into guaranteed income after they retire. And since federal retirement law requires 401(k) plan providers to vet annuity providers to make sure they’re in compliance with state laws and have healthy financial reserves, that could make this avenue more appealing than buying annuities on the open market. Plus, annuities bought through a retirement plan may also benefit from institutional pricing, which means they could come with lower fees.
The annuity offerings from big plan managers like TIAA-CREF and Fidelity are generally aimed at replacing the fixed-income holdings of 401(k) participants. But the greater complexities of annuities (over, say, a mutual fund or ETF) don’t go away just because they’re purchased in the more familiar confines of a 401(k). For example, if you add an annuity to your mix, you will still need to decide when (or whether) to annuitize — that is, convert it into a guaranteed income stream, a decision that’s usually irrevocable.
Bottom line
It can be challenging to understand everything about annuities until you dig in and research the ins and outs. You could also consider an advisory annuity, which is sold through financial advisers rather than insurance agents and could save you a significant amount of money.
Either way, the best thing about an annuity is that you are guaranteed a stream of income during retirement. For that reason, they continue to soar in popularity. But before making a decision, weigh your options because you'll be giving up a substantial amount of cash in return for a guaranteed income for an extended period of time, or for life.
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