If you're a retiree without a pension, annuities can be among the closest alternatives. For retirees with a pension, annuities can fill the gaps it leaves behind, covering expenses your pension may not fully meet. However, annuities come with important trade-offs that are worth understanding.
This guide looks into the pros and cons of annuities to help you decide whether they have a place in your retirement plan.
The Pros of Annuities
Annuities shine at solving the two biggest financial risks in retirement: outliving your savings and market volatility derailing your income at the wrong moment. Once in place, they remove the need to make investment decisions, which becomes increasingly valuable as you age.
For the right person, that combination of guaranteed income, predictability, and simplicity is worth more than the higher returns an investment portfolio might deliver.
1. Guaranteed Lifetime Income
The biggest advantage of an annuity is eliminating longevity risk. Once you purchase a lifetime annuity, you receive regular payments for as long as you live, whether that's 10 years or 40 years. This is the only financial product besides pensions and government programs such as Social Security that provides this guarantee.
For someone retiring at 65, there's a reasonable chance of living another 25–30 years. Without guaranteed income, you face the impossible task of planning withdrawals for an unknown lifespan. Too conservative and you might sacrifice quality of life; too aggressive and you might outlive your savings.
2. Predictable Cash Flow
Market conditions don't affect annuity payments. If your fixed annuity pays $2,500 monthly, you receive exactly $2,500 every month without exception. This stability is particularly valuable in retirement when you have limited ability to recover from financial setbacks.
Knowing your exact income makes budgeting straightforward. You can plan for fixed expenses — housing, utilities, insurance premiums, property taxes — with complete certainty. There's no need to worry about reducing withdrawals in a given month or about sequence of returns risk.
This predictability has psychological value too. Many retirees can sleep better knowing their essential expenses are covered regardless of economic conditions.
3. Tax-Deferred Growth During Accumulation
For deferred annuities, your money grows tax-deferred during the accumulation phase. This means investment gains compound without being reduced by annual taxes. Over many years, this can result in significantly more money available when you start taking payments.
The tax advantage is particularly meaningful if you've already maxed out other tax-advantaged accounts. In the US, 401(k)s and IRAs (Individual Retirement Agreements) have contribution limits. Similar limits apply to SIPPs (Self-Invested Personal Pensions) in the UK, RRSPs (Registered Retirement Savings Plans) in Canada, and superannuation in Australia.
Annuities, on the other hand, have no contribution limits.
4. Simplified Financial Management
After purchasing an annuity, there's nothing for you to manage. No rebalancing decisions, fund selection, or worry about market timing. The payments arrive automatically, month after month.
This matters more as we age. Cognitive decline affects many people in their 70s and 80s. Annuities remove the risk of poor financial decisions during periods of diminished capacity. Family members don't need to step in to manage investments, and you're protected from financial fraud targeting seniors.
5. Protection from Market Downturns
Annuities transfer investment risk to the insurance company. Even if markets crash and stay down for years, your payments don't change. This was particularly valuable for those who retired during the 2008–2009 global financial crisis or the 2022 market downturn — while their friends were watching portfolios plummet, annuity owners received their scheduled payments.
With fixed annuities, the insurance company manages the underlying investments, maintains reserves, and absorbs any shortfall if returns are poor. You're insulated from that volatility.
6. Customization Options Available
Modern annuities offer various features to address different concerns. You can add joint and survivor options so payments continue to your spouse. Period certain guarantees ensure beneficiaries receive payments if you die early. Inflation adjustments maintain purchasing power over decades.
Enhanced or impaired life annuities provide higher payments for those with health issues. Insurers recognize that if you have a shorter life expectancy, you should receive more per month. The rate increases can be substantial — anywhere from 10% for mild lifestyle factors to well over 40% for serious conditions.
The Cons of Annuities
The core trade-off of annuities is giving up flexibility and growth potential in exchange for security. Once your lump sum is converted to income, it's locked away, leaving you exposed if unexpected costs arise. Fixed payments also quietly erode purchasing power over time (although inflation-adjusted annuities can address this at the cost of lower starting income), and fees on more complex products can be substantial, so what looks like a straightforward guarantee often comes with hidden costs.
The suitability question matters too. If you're in poor health, have a shorter life expectancy, or simply want to leave something behind for your heirs, an annuity may not be the best option for you.
1. Lack of Flexibility and Liquidity
Once you purchase an immediate annuity, your lump sum is gone. You cannot access that principal for emergencies, opportunities, or changed circumstances because the money has been converted into a stream of income payments.
This inflexibility creates real problems if you face unexpected expenses. Major home repairs, unexpected medical bills, or family emergencies requiring financial help become difficult to address. You're stuck with your payment schedule regardless of what life throws at you.
Some deferred annuities allow partial withdrawals, though most contracts only permit up to 10% of the account value per year without penalty. Beyond that, surrender charges typically apply — often starting around 7% in the first year and declining gradually over a period of 6–10 years or more. This means you're penalized for accessing your own money.
Beyond surrender charges, accessing annuity money before age 59½ (in the US) typically triggers a 10% tax penalty on earnings. Similar restrictions exist in other countries for tax-advantaged retirement accounts used to purchase annuities. This is another reason why annuities are generally better suited if you're at or near retirement age.
2. Lower Growth Potential and No Inheritance
Annuities typically offer returns in the same general range as high-quality bonds, although outcomes vary by product type and market conditions. Like bonds, they come with lower long-term growth potential than diversified stock portfolios. If you're comfortable managing investments and accepting volatility, keeping money invested may provide better long-term outcomes.
Beyond returns, money in an annuity can't be passed on to heirs. If you die earlier than expected, the insurance company typically keeps whatever principal remains, unless you purchased specific guarantees such as a guaranteed period or value protection. If you value leaving something to your children, grandchildren, or charity, that's a trade-off to consider carefully.
3. Inflation Erosion of Fixed Payments
This is perhaps the most serious drawback of fixed annuities. A $2,000 monthly payment sounds great today. But with around 3% annual inflation — roughly the long-term average in most developed economies, such as the United States — here's what that payment is worth in today's dollars:
- After 10 years: $1,488
- After 20 years: $1,106
- After 30 years: $823
Your payment stays the same, but everything else costs more. What covered your expenses comfortably at 65 barely covers basics at 85.
Inflation-adjusted annuities address this, but require accepting meaningfully lower starting payments — typically around 20–25% less, depending on the rate of adjustment and the provider. You're betting you'll live long enough for the inflation protection to pay off. For many people this trade-off makes sense, but it means significantly less income in the early years of retirement.
4. Fees and Hidden Costs
Annuities, especially variable annuities, can be expensive. Typical annuity costs include:
- Mortality and expense (M&E) charges: 0.25–1.75% annually
- Administrative fees: 0.1–0.3% annually
- Investment management fees (variable annuities): 0.6–3% annually
- Rider costs: 0.25–1.5% annually for each optional feature added
Total fees for complex variable annuities often exceed 3% annually. These drag significantly on returns. Even simpler fixed annuities have costs built into the pricing that effectively reduce your payout.
Commissions paid to selling agents come from somewhere — usually out of your payments. These typically range from 1% to 8% of your premium depending on the product type. Simpler immediate annuities tend to carry commissions of 1–3%, while complex variable or indexed annuities can run 5–8% or more. The cost is often invisible to buyers.
Tax treatment is another hidden cost worth factoring in. Annuity withdrawals are taxed as ordinary income rather than at the lower capital gains rate. This means that, depending on your tax bracket, the lifetime tax bill could actually be higher than if you'd kept the money in a taxable investment account.
5. Counterparty Risk
Your annuity payments depend on the insurance company's financial strength. While insurers are heavily regulated and maintain significant reserves, company failures do occur.
State guaranty associations in the US typically protect up to $250,000 per insurer. The UK's Financial Services Compensation Scheme (FSCS) covers 100% of claims for qualifying annuities. Canada's Assuris protects 90% of benefits or $5,000 monthly, whichever is higher. In short, protection varies by jurisdiction and is not unlimited.
It's worth noting that counterparty risk is only a material concern if your lump sum exceeds the protection limit in your jurisdiction. That said, the US threshold of $250,000 is easier to hit than it sounds. A premium of that size at age 65 might pay around $1,500 a month on a single life immediate annuity, which is less than many people expect.
If your lump sum does exceed the limit, split the purchase across multiple highly-rated insurers. Look for companies rated A or above by AM Best or equivalent ratings from S&P or Moody's, and cross-check across agencies.
Making Your Decision
Understanding the pros and cons of annuities is only half the battle — not all products are created equal. Some, particularly variable annuities with multiple riders, are genuinely complex, and some agents push higher-commission options over simpler ones that would serve you better.
When in doubt, a fee-only financial advisor can help you evaluate whether an annuity is right for your situation — without the bias of commission-based sales.
If you're unsure where to start, check out our What Is an Annuity guide or use our annuity calculator to estimate potential income from different annuity amounts and see if the numbers work for your situation. For more detail on specific products, see our guides on fixed annuities, variable annuities, and types of annuities.