Many baby boomers are reaching the age when it’s time to retire, if they haven’t retired already. This means that they’ll need a plan for where their retirement income will come from.
There are many potential income sources boomers can choose from, including Social Security, stocks, bonds, and annuities.
As you’re preparing for your retirement years and trying to decide where to get your money to live on, annuities may seem like an especially attractive option, given that they offer a guaranteed source of funds that you don’t have to worry will run out. But are they really the best choice to meet your needs in today’s shifting regulatory and economic landscape?
Here’s what you need to know about annuities if you are considering incorporating them into your retirement plans.
Are annuities a good option for your retirement?
There are pros and cons of choosing to include an annuity as a source of retirement income. Some of the pros include:
- Guaranteed lifetime income: This is the single biggest advantage of selecting an annuity. You can buy an annuity that’s guaranteed to last for a set period of time, such as 10 or 20 years. Or, you can select an annuity guaranteed to last either for the duration of your own life or for the duration of a joint life. Unlike other income sources, such as money in a 401(k), you will not have to be concerned about the money running out.
- Tax-advantaged investment: When your annuity is in the growth or accumulation phase, you can benefit from tax-free growth. On the other hand, if you opt for a non-qualified annuity, you can also collect some of your money tax-free in retirement since you aren’t taxed on the return of the premiums.
- Sequence of Returns Buffer: Annuities provide protection against market risk by acting as a volatility buffer. This prevents retirees from being forced to sell equities during market downturns, effectively preserving the longevity of the remaining investment portfolio.
Of course, there are also downsides as well. Some of the disadvantages include:
- High fees and Regulatory Shifts: Annuities tend to come with significant administrative and management fees. Furthermore, the official vacatur of the Department of Labor’s 2024 Retirement Security Rule by the U.S. District Court in Federation of Americans for Consumer Choice v. DOL—and its subsequent removal from the Code of Federal Regulations—means regulatory oversight has reverted to older, less stringent frameworks, requiring investors to be far more diligent in vetting broker claims.
- Limited liquidity: You can’t typically access your funds early without facing high surrender charges. If you try to cash out your annuity within the first few years, you could lose as much as 10% of the contract value.
- Inflation risk: If you pick a fixed annuity, you will end up losing buying power over time. Unlike Social Security, which provides a cost-of-living adjustment (COLA), most fixed annuities offer a stagnant payout that does not keep pace with rising prices.
The Modern Shift: “Peak 65” and the Rise of RILAs
With the historic “Peak 65” demographic wave driving retail annuity demand to record highs across the industry, product structures have evolved significantly. Rather than relying solely on traditional fixed or variable contracts, savers are increasingly utilizing Registered Index-Linked Annuities (RILAs). These hybrid vehicles allow investors to capture market-linked growth up to a specified cap while embedding a defined downside protection buffer, such as shielding the portfolio against the first 10% to 20% of market losses during periods of high volatility.
Is an annuity right for you?
While guaranteed income is appealing, savvy investors often compare annuity payouts against modern dividend growth strategies to see which provides better long-term yield. Many retirees find that there are more upsides than downsides to annuities, but you’ll need to carefully weigh the pros and cons and look at the full picture as you make your choice about whether an annuity should be a part of your retirement plan.
Capital Deployment: Annuities vs. Dividend Growth Portfolios
| Feature | Fixed / Indexed Annuities | Dividend Growth Portfolio (e.g., SCHD, VIG) |
|---|---|---|
| Income Guarantees | Contractually guaranteed for life by the issuing insurance carrier. | No guarantees; corporations can cut or suspend dividends during market contractions. |
| Principal Liquidity | Restricted; early withdrawals beyond penalty-free limits trigger multi-year surrender charges. | High; equities and index ETFs can be fully liquidated at current market value on any trading day. |
| Inflation Protection | Poor; fixed streams lose purchasing power unless a costly, compounding rider is attached. | High; historical dividend growth rates from high-quality firms consistently outpace inflation. |
| Fee Overhead | Often higher due to underlying administrative layers, riders, and insurance expense structures. | Extremely low; minimal drag when utilizing broad, passive dividend growth index funds. |
Editor’s Note: This article has been updated to incorporate the federal court vacatur of the Department of Labor’s 2024 Retirement Security Rule in Federation of Americans for Consumer Choice v. DOL, analysis of shifting demographic trends driving record industry sales volumes, an evaluation of Registered Index-Linked Annuities (RILAs) as downside protection options, and a side-by-side structural comparison against equity-based dividend growth investment models.
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