Annuities often spark strong opinions. Some investors see them as a secure, reliable income stream, while others view them as overpriced, opaque, and riddled with commissions.

Who’s right?

The truth lies somewhere in between. Like most financial products, annuities can be helpful or harmful, depending on how they're used. Here’s a closer look at the evidence.

What is an annuity?

An annuity is a contract between you and an insurance company. In exchange for a lump sum or series of payments, the insurer agrees to provide income immediately or in the future.

There are many types: immediate vs. deferred, fixed vs. variable, indexed vs. income-focused. Some are simple, others complex.

At its core, an annuity is a tool for converting assets into income.

The case for annuities

Here are some of the main benefits of annuities, highlighting how they can provide financial security through guaranteed income for life and other key advantages.

1. Longevity protection

People are living longer. That’s great news, unless you outlive your savings. One of the most valuable features of an income annuity is that it guarantees payments for life, no matter how long you live.

Studies show that retirees consistently underestimate how long they’ll live.

Annuities can act like a personal pension. You hand over a chunk of money and receive predictable, monthly payments.

2. Behavioral value

Annuities can help you manage your spending.

You make withdrawal decisions when you rely on a 401(k) or IRA. That flexibility is appealing, but it also invites risk. You might spend too much too early. Or be so fearful of overspending that you underlive your retirement.

Research has found that retirees with guaranteed income streams, like Social Security and annuities, report higher satisfaction and less stress than those drawing solely from portfolios.

3. Tax deferral

With deferred annuities, your investment grows tax-deferred. You don’t pay taxes on earnings until you withdraw.

That can benefit high earners who’ve maxed out their 401(k) and IRA contributions. However, it comes with a trade-off: withdrawals are taxed as ordinary income, not capital gains.

4. Downside protection

Some annuities, like fixed indexed annuities (FIAs), promise growth linked to a market index, but with a floor that protects you from losses. This appeals to risk-averse investors.

But be cautious. These products often have caps and participation rates that limit your upside. The fine print matters.

The case against annuities

While annuities can offer certain benefits, they must be weighed against the potential drawbacks, starting with their high costs.

1. High fees and commissions

Some annuities are costly.

Variable annuities often include mortality and expense charges, administrative fees, investment subaccount fees, and riders.  

These products typically come with high commissions, ranging from 5% to 10%. These commissions can influence the recommendations you get, potentially leading to biased advice.

Low-cost options exist, but they’re harder to find. Fee transparency is critical if you’re going to consider an annuity.

2. Complexity and lack of liquidity

Many annuities are difficult to understand. The language is dense, and the riders are confusing. Even seasoned investors can feel overwhelmed.

Once you’re in, getting out can be painful. Most annuities have surrender periods lasting 5 to 10 years, and early withdrawals trigger steep penalties.

You’re trading liquidity for predictability. That has consequences.

3. Tax treatment can be a drawback

While tax deferral is a benefit, how annuity income is taxed can be unfavorable.

Withdrawals from non-qualified annuities (funded with after-tax money) are taxed under the LIFO rule: earnings come out first and are taxed as ordinary income. Only after the earnings are exhausted do your principal withdrawals begin.

If you’re in a high tax bracket, this can sting. You could pay more tax than on a comparable portfolio because annuity income doesn’t qualify for capital gains treatment.

4. Better alternatives may exist

Here’s the uncomfortable truth: most investors don’t need annuities.

If you have a diversified portfolio and the discipline to manage withdrawals, you can often create your own “synthetic pension” using low-cost index funds and a rules-based spending strategy.

The "guardrails" approach helps manage withdrawals from an investment portfolio while ensuring sustainability. Setting limits allows you to adjust withdrawal amounts based on market performance and individual needs. For example, in a strong market, you might withdraw more.  In a downturn, you would reduce withdrawals to protect your assets.

No fees. No complexity.

Where the research lands

There’s no universal verdict on annuities.

Annuitizing at least part of your portfolio may make rational sense, especially for covering “non-discretionary” spending like housing, food, and healthcare.

Yet take-up rates remain low. Most retirees don’t buy annuities, even when they’d benefit.

Why? Behavioral biases, lack of trust in insurance companies, fear of losing liquidity, and poor financial literacy play a role.

A place for annuities in a portfolio

Despite their downsides, annuities can play a role in a well-designed retirement plan.

Here’s when they might be worth considering:

• You’re worried about outliving your money. Lifetime income annuities can reduce that risk.
• You’re a conservative investor. Annuities may align with your preference for stable income.
• You lack a pension. An annuity can serve as a pension substitute.
• You want to simplify retirement. For some, turning a portion of savings into a paycheck brings relief.
• You value peace of mind more than upside. That’s a valid trade-off, especially in later years.

What to watch for

If you decide to explore annuities, ask these questions:

1. What type of annuity is this? Income? Deferred? Variable? Indexed?
2. What are the all-in fees?
3. How is the payout calculated?
4. What’s the surrender schedule?
5. What riders are included, and at what cost?
6. How are taxes calculated?
7. Is the annuity being sold by a fiduciary or a commissioned salesperson?

Clarity is your friend. Don't sign the contract if you don’t fully understand the product.

Conclusion: worth it or not?

Annuities aren’t inherently good or bad. They’re financial tools, useful in some situations, inappropriate in others.

Annuities can be a valuable addition for some retirees, particularly those with long life expectancies and a need for stable income. For others, they may offer too little flexibility at too high a cost.

Evidence shows that when used thoughtfully, annuities can help reduce financial anxiety and improve retirement outcomes.