Mo Money's Building Wealth Blog

Let’s talk about annuities today, specifically fixed annuities, as they are something that has intrigued me as a possible way of getting some guaranteed fixed income and returns in retirement.  As a quick primer a fixed annuity is a contract that you can purchase from an insurance company where they pay you a fixed monthly amount (either immediately or deferred to a later date).  The amount of the monthly payment that you receive depends upon the contract purchase price which typically can be purchased as a lump sum or in installments over time.  These payments are guaranteed by the insurance company for your remaining life, regardless of market and interest rate fluctuations. 

Experts recommend that a portion of your retirement assets should be held in fixed income type of investments – e.g. CDs, Treasuries, bonds, fixed annuities, etc.  I’ve always heard that annuities (broad generalization as there are many variations) were a bad idea, but I decided to dig a little deeper to see if they might make sense.  Here’s what I found –

Pros

• As far as investments go, they are easy to understand.
• The interest rate is fixed for the life of the contract, so no surprises.
• You have a reliable source of income for life.  This can help when applying for loans or foreign retirement visas.
• Some variations provide for continued payments to a surviving spouse and for a residual death benefit.

Cons

• You lose the flexibility to access the underlying cash invested in the event that you might need it.  Some offer early withdrawal options, but they can come at substantial penalties.
• Because the initial rate is locked in for life they can’t ever adjust for inflation.
• While “guaranteed” by the insurance company what happens if the company goes bankrupt?  There are state bailout provisions but is it really 100% guaranteed?
• The payments are considered ordinary income and are taxed as such, versus stock market returns which could be taxed as long-term capital gains – currently only 15% for most retirees.  So, it might not be a great idea for retirees in higher income brackets.
• Depending on the contract specifics, payments could end at your death with nothing left for your heirs.

Pro Tip – There are many free tools on the web that can help you estimate what a fixed annuity could pay you.  I like these because you don’t have to speak with any annoying salesperson or be hounded afterward.  I typically like tools that don’t require you to leave contact information.  Here’s a free fixed annuity calculator from Charles Schwab that you can use anonymously.

So, while I have always been reluctant to consider an annuity, I think that fixed annuities could have their place in my retirement portfolio, especially because I expect to be in a lower tax bracket.  I just might consider putting some small percentage of my retirement fixed-income assets in one.  I kindof consider it to be a long-term CD but without the FDIC insured guarantee that goes with it. 

So, what do you think?  I’d love to get some opinions on this topic.