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Annuities Explained: Pros and Cons
Put $500,000 into an immediate annuity at 65 and a competitive quote pays roughly $2,900 to $3,200 a month for life — about 7% of the principal a year, guaranteed by an insurer for as long as you live. No balanced portfolio can promise that. The trade: the insurer keeps what remains when you die.
The Main Types
- Immediate annuity: lump sum today, income starting now. Simplest product, closest to a DIY pension.
- Deferred income annuity: pay now, income starting at 75 or 80. Very high payout rates because the waiting period is long — a longevity hedge rather than a full portfolio replacement.
- Fixed indexed and variable annuities: growth-linked products wrapped in insurance features, with fee stacks that often run 2% to 3.5% a year. These are where most consumer complaints originate.
Honest Pros
Guaranteed lifetime income removes sequence-of-returns risk entirely — no market crash can cut the check. Insurer solvency is backstopped by state guaranty associations up to set limits, typically $250,000 in present value per insurer per person, which argues for splitting large purchases across two or more highly rated carriers. Annuity income also relaxes the 4% rule math on the rest of the portfolio: a retiree whose essentials are covered by Social Security plus an annuity can invest the remainder more aggressively.
Honest Cons
Liquidity disappears — most contracts allow no meaningful surrender after the income starts. Inflation erodes level payments unless a COLA rider is bought, cutting the starting check by 25% or more. Fees on variable products compound silently against returns. And legacy value goes to the insurer unless a period-certain or refund feature is purchased, each of which lowers the monthly payout. Pre-tax money used to buy an annuity keeps its ordinary-income tax treatment on every payment.
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