Annuities.
Useful for some, oversold to many.
An annuity is a contract with an insurance company that converts a lump sum into an income stream. Some annuities are useful. Many are sold to the wrong people at the wrong price. Here is how to tell the difference.
US-only. Annuity products and tax treatment are US-specific.
The annuity that makes sense for most people is a Single Premium Immediate Annuity (SPIA) for a portion of retirement assets, trading a lump sum for guaranteed income. Variable annuities, equity-indexed annuities, and any annuity inside an IRAIndividual Retirement Account (IRA)A personal retirement savings account with tax advantages. Two main types: Traditional (tax now, pay later) and Roth (pay now, tax-free forever).Full definition are almost never the right choice.
Section 1 · The types
Immediate annuity (SPIA)
- Pay a lump sum. Receive monthly payments for life (or a fixed period).
- Transfers longevity risk to the insurance company.
- Legitimate use case: you are 70, have $200,000, worry about outliving your money. Trade $200,000 for approximately $1,200/month guaranteed for life. If you live to 95, you come out ahead. If you die at 75, you do not. The honest trade: you are buying longevity insurance, not an investment.
Deferred annuity
- Accumulate first, convert to income later.
- Various subtypes: fixed, variable, indexed.
- Often has surrender charges if you access the money early (7-10 year lock-up).
- Commission to the seller: often 5-8% of the amount.
Variable annuity
- Tax-deferred investment account wrapped in an insurance contract.
- Invested in mutual-fund "subaccounts."
- Higher fees than just owning the mutual funds directly (often 2-3%+/year).
- Inside an IRA: completely pointless, IRAs are already tax-deferred.
- Inside a taxable account: tax-deferral advantage rarely justifies the higher fees.
- This is the annuity most commonly sold to people who do not need it.
Equity-Indexed Annuity (EIA)
- Returns tied to an index with a floor and a cap (similar to IUL).
- Complex. High commissions. Difficult to evaluate.
- Surrender charges can be 10-15 years.
- If you need the floor, buy a fixed annuity. If you want market exposure, buy an index fund. The combination rarely beats the simpler components.
Section 2 · The commission problem
Annuities pay some of the highest commissions in financial products. Variable annuity commissions: often 5-7% of the amount invested verify×DON'T TRUST, VERIFYClaim: Variable annuity commissions are commonly 5-7% of premium.Verify at: SEC Variable Annuity guidance ↗SEC requires prospectus disclosure of all charges. Compare commission against direct-purchase fund costs..
This creates a strong incentive for commission-based advisors to recommend annuities regardless of suitability. The tell: if an advisor is recommending an annuity inside an IRA (where there is zero tax benefit from the annuity wrapper), question the recommendation closely. See /how-to-find-a-fiduciary/.
Section 3 · When annuities make sense
An SPIA (immediate annuity) makes sense when:
- You have more assets than you can spend in a moderate market crash but worry about living very long.
- Converting a portion (not all) of retirement assets to guaranteed income reduces sequence-of-returns risk on the rest.
- You have no pension and Social Security will not cover basic expenses.
Size: not more than necessary to cover basic expenses above Social Security. Leave the rest invested.
- SEC. Variable Annuities: What You Should Know · sec.gov/investor/pubs/varannty.htm.
- FINRA. Annuities · finra.org.