Do Annuities Belong in Your Retirement Plan? With Jeremiah Konger

When does an annuity make sense in retirement? Learn about four broad types of annuities, how their features differ, and what to consider before adding one to a retirement plan.

Some people say they hate annuities.

Other people say they love annuities.

Annuities can’t simultaneously be the best financial product for everybody and the worst financial product for everybody. More importantly, “annuity” describes a broad category of insurance products that can work very differently from one another.

So perhaps there’s a better question to ask:

When does an annuity actually make sense in retirement?

I recently discussed that question with Jeremiah Konger of Annuity Association. Jeremiah specializes in annuities, so I especially wanted to hear him explain not only why someone might consider one, but also when an annuity might not belong in the plan.

We kept coming back to a principle that applies well beyond annuities.

Start with the retirement planning process. Identify what you’re trying to accomplish. Then determine which financial tool, if any, fits that need.

“Annuity” Doesn’t Describe Just One Thing

One reason the annuity debate becomes confusing is that people use one word to describe products designed to do very different things.

Jeremiah broke annuities into four broad categories.

A single premium immediate annuity, or SPIA, generally involves exchanging a lump sum for an income stream. Depending on the contract and elections made, that income might continue for a defined period or for one or more lifetimes.

A multi-year guaranteed annuity, or MYGA, is a type of fixed annuity that credits a specified interest rate for an agreed-upon period. Jeremiah compared its basic purpose to a bank CD, while noting that the two aren’t identical and can have different restrictions and protections.

A variable annuity generally provides investment options whose values can fluctuate. Depending on the particular contract, it may also include optional features or riders, which can add costs and complexity.

Jeremiah also discussed registered index-linked annuities, or RILAs, as a subset of the variable annuity category. These products can provide market-linked returns subject to contractual caps or other participation limits while using buffers or similar mechanisms to absorb a specified portion of losses. Losses can still occur when declines exceed the applicable contractual protection.

Finally, a fixed indexed annuity is a fixed insurance product whose credited interest may be linked to the performance of an external market index according to the terms of the contract. The owner isn’t directly invested in that index. Contractual provisions determine how interest is calculated, and guarantees depend on the claims-paying ability of the issuing insurer.

Already, you can see the problem with saying simply, “Annuities are good” or “Annuities are bad.”

Which annuity? And what are you asking it to do?

Those questions matter much more.

Don’t Confuse a Product Feature With a Retirement Plan

Jeremiah made a comment during our discussion that I thought captured the right way to approach the subject:

“Annuities are a planning tool.”

Problems arise when we start with the product.

Maybe someone hears about an attractive interest rate and decides they need an annuity. Someone else hears the words “guaranteed income” and immediately assumes an annuity belongs in the portfolio. Another person had a bad experience with one type of annuity 20 years ago and concludes that no annuity should ever be considered.

I’d rather work in the opposite direction.

What does your retirement plan need?

Perhaps you’re delaying Social Security and want to determine how you’ll fund the years before those benefits begin.

Perhaps you’re concerned about maintaining a certain amount of income for as long as you or your spouse lives.

Perhaps you have money with a specific short-term or intermediate-term purpose and want to compare the available options.

Or perhaps your retirement plan doesn’t present a problem that an annuity needs to solve at all.

Once you’ve identified the objective, you can compare the financial tools that might address it. An annuity may be one of those tools. It shouldn’t automatically be the starting point.

The Details of the Contract Matter

One of the biggest misconceptions Jeremiah encounters is that buying an annuity always means giving up control of your money.

That idea likely comes in part from traditional immediate annuities. With certain forms of immediate annuity, you exchange a lump sum for a contractual stream of payments. But even within that category, different payout and beneficiary options may be available.

Other annuity types work differently.

The same problem arises with fees. Some people hear “annuity” and assume every contract has layers of explicit annual fees. Jeremiah pointed out that variable annuities have historically been associated with various contract, investment, and rider expenses, while other types of annuities can have very different cost structures.

That doesn’t mean a product without an explicit annual fee has no economic tradeoffs.

Annuities can include surrender periods, withdrawal restrictions, caps, participation rates, spreads, contractual limitations, tax considerations, and other features that affect what you ultimately receive and how much flexibility you have.

That’s why you need to evaluate the actual contract rather than make a decision based on the word annuity.

A Guarantee Is Only as Strong as the Company Making It

We also spent time discussing the word guarantee.

That’s an especially important word to understand with annuities.

An annuity isn’t a bank account, and its guarantees aren’t FDIC insurance. Contractual guarantees are backed primarily by the claims-paying ability of the insurance company that issued the annuity.

That means the financial strength of the issuing insurer matters.

Jeremiah also discussed state insurance guaranty associations, which can provide certain protections subject to state-specific laws and coverage limits if an insurer becomes insolvent. Those protections are different from FDIC insurance and shouldn’t be the primary reason to purchase a particular contract.

If you’re evaluating an annuity, understand exactly who is making the guarantee, what is guaranteed, and what contractual conditions apply.

The word “guaranteed” by itself isn’t enough information to make a retirement decision.

When Might an Annuity Not Make Sense?

Because Jeremiah works in the annuity business, I specifically wanted to ask him who might not need one.

His answer brought us back to the planning process.

An annuity isn’t something you add simply because you’ve reached a particular age or accumulated a certain amount of money. Jeremiah described it as a tool that needs an appropriate application within the overall retirement plan.

If you’ve identified your income needs, considered the risks you’re concerned about, and determined that other resources already address those needs in a way you’re comfortable with, you shouldn’t force an annuity into the plan simply because someone says retirees are supposed to own one.

Conversely, being comfortable with stock-market volatility doesn’t necessarily settle the question either. A household may have other concerns, including the income available to a surviving spouse or how the finances would be managed if the spouse who has historically handled the investments were no longer able to do so.

Those are planning questions.

The annuity comes later.

Income Can Be One Piece of the Retirement Foundation

Jeremiah uses the analogy of building a house.

Before you build the rest of the house, you need a foundation. In his approach, predictable retirement income can form part of that foundation.

Social Security and pensions may provide some of that income. Depending on the household’s circumstances, an annuity with contractual income guarantees could potentially provide another source.

I think the important part is determining how much predictable income you actually want.

Some retirees are comfortable allowing a larger portion of their spending to depend on withdrawals from an investment portfolio. Others place a higher value on having more of their essential expenses supported by income sources that aren’t directly dependent on short-term stock-market performance.

Neither preference automatically tells us what product someone should buy.

It tells us something about the retirement plan we’re trying to build.

Once you know the income need, you can evaluate the available tools and the tradeoffs that come with each of them.

Be Careful With Investment Comparisons

Jeremiah also described a hypothetical strategy in which an annuity could replace part of a traditional bond allocation, potentially allowing the remaining investment portfolio to hold a larger percentage of equities.

That’s an interesting planning concept, but it’s important not to turn it into an assumption about future results.

A portfolio with a larger equity allocation can experience substantial losses. Historical market returns don’t tell us what the next decade will produce, and an average historical return doesn’t mean an account will grow at that rate each year—or double on a predictable schedule.

The appropriate allocation still depends on the investor’s circumstances, risk tolerance, time horizon, income needs, and overall financial plan.

This is another reason I come back to the same principle: the process should determine the product and investment strategy, not the other way around.

Ask These Questions Before Considering an Annuity

Before deciding whether an annuity belongs in your retirement plan, I’d want to understand several things.

What problem are you trying to solve?

Do you need additional retirement income? If so, when does that income need to begin, how long does it need to last, and does it need to cover one life or two?

How much liquidity do you need? What happens if you need access to more money than the contract permits without a surrender charge?

What exactly is guaranteed, and which parts of the potential return aren’t?

How are interest or investment returns calculated?

What are the fees, surrender charges, caps, participation rates, spreads, riders, or other limitations?

What happens when you die?

How financially strong is the insurance company making the contractual promises?

And perhaps most importantly: What alternatives have you compared?

An annuity shouldn’t have to win an argument about whether annuities are universally good or bad.

It only needs to be evaluated against the other tools available for the particular job your retirement plan needs done.

Start With Your Retirement Master Plan

That’s ultimately where Jeremiah and I landed.

Don’t start with “I love annuities.”

Don’t start with “I hate annuities.”

Start with your retirement.

Determine how much you expect to spend, where your retirement income will come from, how taxes fit into the picture, what your investments need to accomplish, and what you want to leave behind.

Then look for the financial tools that support those goals.

Sometimes that may include an annuity.

Sometimes it may not.

The goal isn’t to own the right product. The goal is to build the right retirement plan for you.

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About the Author:

Jeremy Keil, CFP^®, CFA is a retirement financial advisor with Keil Financial Partners, author of Retire Today: Create Your Retirement Income Plan in 5 Simple Steps, and host of the Retire Today blog and podcast, as well as the Mr. Retirement YouTube channel.

Jeremy is a contributor to Kiplinger and is frequently cited in publications like the Wall Street Journal and New York Times.

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Additional Links:

• Buy Jeremy’s book – Retire Today: Create Your Retirement Master Plan in 5 Simple Steps
• Jeremiah Konger on LinkedIn
• NetEasyAnnuities.com 
• AnnuityAssociation.com 
• “I Love Annuities Podcast” with Jeremiah Konger and Zacharay Van Es

Connect With Jeremy Keil:

• Keil Financial Partners
• LinkedIn: Jeremy Keil
• Facebook: Jeremy Keil
• LinkedIn: Keil Financial Partners
• YouTube: Mr. Retirement
• Book an Intro Call with Jeremy’s Team

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