What an annuity does and does not do for retirement
An annuity converts a lump sum of money into regular payments for the rest of your life, or for a set number of years. Whether that fits your retirement depends entirely on what you need the money to do and what you are willing to give up to get those payments.
An annuity's main strength is certainty: once you buy one, you know exactly how much will arrive each month, and that payment does not change if the stock market drops or interest rates rise. That matters most if you are worried about running out of money or if you have already retired and cannot earn more income. An annuity's main weakness is inflexibility: once you buy one, you cannot get your money back if your circumstances change, and the payments stop when you die — unless you pay extra for a survivor benefit, which reduces what you receive each month.
The question is not whether annuities are good or bad in general. It is whether the trade-off — may provide income now in exchange for access to your money later — matches what you actually need.
Key Takeaways
- An annuity locks in a monthly payment amount for life or a set period, which removes uncertainty about income but removes your ability to access the principal if your situation changes.
- Annuities cost more than the money you put in because the insurance company keeps a portion to cover its costs and profit, so you receive less total money over time than if you invested the same amount yourself.
- The longer you live, the better an annuity looks financially; if you die within a few years, you will have received less than you paid in unless you bought a survivor benefit.
- Annuities work best alongside other retirement income sources like Social Security or a pension, not as your only retirement plan.
- The type of annuity you choose — when ready, deferred, fixed, or variable — changes what you pay, what you receive, and what risks you carry.
How much an annuity actually costs you
When you buy an annuity, you pay the insurance company a sum of money upfront. In return, they promise to pay you a set amount each month. The monthly payment is always less than what you would receive if you straightforward divided your initial payment by the number of months you expect to live. The difference is the insurance company's cost, profit, and the risk they take on.
For example, if you put $100,000 into an when ready annuity at age 65, you might receive roughly $500 to $600 per month for life, depending on current interest rates and the insurance company's pricing. Over 20 years, that totals $120,000 to $144,000 — more than you paid in. But if you die at 75, you will have received only $60,000 to $72,000, which is less than your initial $100,000. The insurance company keeps the rest.
This is not a flaw in annuities; it is how they work. The company is betting you will live longer than average, and you are betting you will live longer than average. One of you will be right. The cost of that bet is built into the monthly payment.
When may provide income matters most in retirement
An annuity makes the most sense when you have already calculated how much money you need each month to cover essential expenses — housing, food, utilities, healthcare — and you want to know that amount will arrive no matter what happens in the stock market or the economy.
If you already receive Social Security and a pension, and those two sources cover your basic needs, an annuity may not add much value. You already have may provide income. If you have only Social Security and no pension, and you are worried about outliving your savings, an annuity can fill that gap by converting part of your savings into a may provide monthly check.
An annuity also matters if you have a large lump sum from a 401(k) rollover or an inheritance and you do not want to manage investing it yourself. Some people find the simplicity of a fixed monthly payment worth the cost.
The flexibility problem: what happens if you need your money back
Once you buy an annuity, your money is gone. You cannot withdraw the principal if an emergency arises, if your health changes, or if you change your mind. Some annuities allow small withdrawals, but they usually come with surrender charges — penalties that can be 5 to 10 percent or higher in the early years.
This matters most in the first 5 to 10 years after you buy an annuity. If you need access to a large sum of money during that time, an annuity will cost you significantly to undo. After 10 or 15 years, depending on the contract, surrender charges usually drop to zero, but by then you have already committed to the arrangement.
If you have other savings you can tap for emergencies — a separate savings account, a brokerage account, or a home equity line of credit — an annuity becomes less risky. If an annuity would be your only accessible money, the inflexibility becomes a real problem.
How your age and life expectancy affect the math
The older you are when you buy an annuity, the higher your monthly payment, because the insurance company expects to pay you for fewer years. A 75-year-old buying an when ready annuity receives more per month than a 65-year-old with the same initial payment, because the 75-year-old's payments will likely end sooner.
This creates a break-even point. If you die before that point, you lose money on the annuity compared to investing the same amount yourself. If you live past it, you come out ahead. The break-even age varies by the annuity type and current interest rates, but it typically falls somewhere between 80 and 85 for someone who buys an when ready annuity at 65.
If your family history suggests you will live into your 90s, an annuity becomes more attractive financially. If serious health problems make that unlikely, an annuity is probably not the right choice. Your doctor's assessment of your health matters more than your age alone.
when ready annuities versus deferred annuities
An when ready annuity starts paying you within a month or two of purchase. You give the insurance company money now, and they start sending checks right away. This works if you are already retired and need the income to start when ready.
A deferred annuity takes your money now but does not start paying you until a future date you choose — often 5, 10, or 20 years later. During the waiting period, your money grows, either at a fixed rate or tied to the stock market. When the payout period begins, you receive a higher monthly payment than you would have from an when ready annuity with the same initial investment. This works if you are still working, do not need the income yet, and want to lock in a future payment amount.
Deferred annuities are more complex because they involve two separate decisions: how much to invest now, and when to start receiving payments. They also carry more risk during the waiting period if the annuity is variable (tied to market performance). when ready annuities are simpler: you buy them close to or after retirement, and the payments begin almost at once.
Fixed annuities versus variable annuities
A fixed annuity pays you the same amount every month for life, no matter what happens to interest rates or the stock market. The insurance company bears the investment risk. Your payment is predictable, but it does not increase if inflation rises or if markets perform well.
A variable annuity ties your monthly payment to the performance of investments you choose — usually mutual funds or index funds. If those investments perform well, your payment increases. If they perform poorly, your payment decreases. You bear the investment risk, not the insurance company. Variable annuities are more complex, usually cost more in fees, and require you to make ongoing investment decisions.
For most retirees, a fixed annuity is simpler and more aligned with the goal of may provide income. A variable annuity makes sense only if you want some chance of higher payments in exchange for accepting the risk of lower payments.
What to consider before buying an annuity
Before you commit to an annuity, write down your essential monthly expenses — the amount you absolutely must have to cover housing, food, utilities, and healthcare. Then add up what you will receive from Social Security, pensions, and any other may provide income sources. The gap between those two numbers is what an annuity could fill.
Next, decide how much of your savings you are willing to convert into an annuity. Most financial advisors suggest keeping some money in liquid savings or investments for emergencies and flexibility. Converting your entire retirement savings into an annuity removes all flexibility and can leave you vulnerable if circumstances change.
Finally, compare quotes from at least three insurance companies. The monthly payment for the same initial investment can vary by 10 to 20 percent between companies. Shop around before you buy.
Frequently Asked Questions
What happens to my annuity payments if I die before I break even?
That depends on the type of annuity you bought. A basic when ready annuity with no survivor benefit stops paying when you die — the insurance company keeps any remaining balance. If you bought a survivor benefit or a period-certain annuity (which guarantees payments for a set number of years), your beneficiary receives the remaining payments or a lump sum. Survivor benefits reduce your monthly payment, so you pay for that protection upfront.
Can I change my mind after I buy an annuity?
Most annuities have a surrender period, usually 5 to 10 years, during which you can withdraw your money but pay a penalty — often 5 to 10 percent of the withdrawal amount. After the surrender period ends, you can usually withdraw without penalty, though you lose the may provide income stream. Read your contract to know your specific terms.
How does inflation affect annuity payments?
A fixed annuity pays the same dollar amount every month for life, so inflation erodes its purchasing power over time. Some annuities offer inflation riders that increase your payment by a set percentage each year, but these cost more upfront and reduce your initial payment. Without an inflation rider, a $500 monthly payment in 2024 will buy less in 2034.
Is an annuity the same as a pension?
Both provide may provide monthly income for life, but they work differently. A pension is funded by your employer and paid from a pool of money. An annuity is funded by you and backed by an insurance company. If your employer offers a pension, that is usually a better deal because the employer bears the investment risk. An annuity is what you buy yourself when you do not have a pension.
What if the insurance company goes out of business?
Each state has a guaranty association that protects annuity holders if an insurance company fails. The protection limit varies by state but is typically $250,000 per person per company. Before you buy an annuity, check that the insurance company has a strong financial rating from agencies like A.M. Best or Moody's.