When an Annuity Makes Sense for Your Retirement

An annuity is a trade-off: you give up access to a lump sum of money now, and the insurance company pays you a steady income later

Whether you should buy an annuity depends on three things: how much may provide income you need in retirement, whether you have other sources of that income already, and how much you can afford to lock away. An annuity is not right for everyone, and it is not wrong for everyone. It is a tool that solves a specific problem — the risk that you will run out of money before you die — but it creates a different problem: you cannot access the money if you change your mind.

Most people who buy annuities do so because Social Security alone will not cover their basic expenses, and they want to stop worrying about whether their savings will last. Some buy them because they have a large inheritance or pension payout and want to convert part of it into predictable monthly checks. Others buy them because they are uncomfortable managing investments and prefer to hand that job to an insurance company.

The decision is personal and depends on your specific situation. This guide walks through the main reasons people buy annuities, the reasons they do not, and the questions you should answer before you decide.

Key Takeaways

• An annuity converts a lump sum into monthly payments that last for life or a set number of years, which removes the risk that you will spend your savings too fast.
• You should only buy an annuity with money you are certain you will not need to access in the next five to ten years, because early withdrawal penalties are steep.
• An annuity makes more sense if you have a long life expectancy, because you collect more total payments and the insurance company's bet on your lifespan works in your favor.
• If Social Security and a pension already cover your basic living expenses, an annuity is usually unnecessary and may lock up money you could use more flexibly.
• The cost of an annuity — the fees the insurance company charges — varies widely, so comparing quotes from multiple insurers is essential before you commit.

When an annuity solves a real problem

An annuity is most useful when you have a gap between what you know you will spend and what you know you will receive. For example: your monthly expenses are $4,000, Social Security will pay you $2,500, and you have $300,000 in savings. An when ready annuity can convert that $300,000 into roughly $1,500 per month for life, which closes the gap and means you never have to think about whether your savings will last.

This is the core reason people buy annuities. They want certainty. They do not want to check their account balance every month or worry that a market downturn will force them to cut spending. They want to know that a check will arrive on the same day every month, no matter what happens in the stock market or the economy.

An annuity also makes sense if you have received a large lump sum — from an inheritance, a pension buyout, or a lawsuit settlement — and you do not trust yourself to manage it. Handing it to an insurance company in exchange for monthly payments removes the temptation to spend it all at once or make poor investment decisions.

When an annuity locks up money you might need

The biggest drawback of an annuity is that you cannot get your money back. Once you hand over the lump sum, it is gone. If you need $10,000 for a medical emergency or a home repair, you cannot withdraw it from an annuity without paying a steep penalty — often 10 percent or more of the withdrawal amount, plus taxes and potential surrender charges that can run 5 to 10 percent in the first several years.

This matters most if you are young, in good health, or have significant medical expenses ahead. If you are 55 and expect to live another 35 years, locking money away in an annuity means you cannot touch it for three and a half decades. If your health changes or your circumstances shift — a grandchild needs help with college, your roof needs replacing, you want to travel — you will face a painful choice between paying the penalty or going without.

An annuity also does not make sense if you already have enough may provide income. If Social Security and a pension cover all your basic expenses and you have additional savings for emergencies and discretionary spending, an annuity adds nothing. You are already protected against running out of money, and converting more savings into an annuity just reduces your flexibility.

How your age and health affect the decision

An annuity is a bet on how long you will live. The insurance company calculates the monthly payment based on life expectancy tables. If you live longer than average, you win — you collect more total money than you paid in. If you die sooner than average, the insurance company wins and keeps the remainder.

This means an annuity is more attractive if you have a long life expectancy. If you are 65, in good health, and your parents lived into their 90s, an annuity is a better deal because you will collect payments for 25 or 30 years. If you are 75, have serious health problems, and your family history suggests you will not live past 85, an annuity is a worse deal because you will collect payments for only 10 years.

The insurance company knows this too, so they will offer lower monthly payments to someone who is older or has health problems. A 65-year-old might receive $500 per month for every $100,000 invested, while a 75-year-old might receive $700 per month for the same investment. The older person gets more per month, but collects for fewer months.

What to compare when you are shopping for an annuity

If you decide an annuity makes sense for your situation, the next step is to get quotes from multiple insurance companies. The monthly payment you receive will vary based on several factors, and shopping around can mean a difference of hundreds of dollars per year.

The main things to compare are the monthly payment amount, the fees the insurance company charges, and the guarantees included in the contract. Some annuities are straightforward: you hand over a lump sum and receive a fixed monthly payment for life. Others include options like a survivor benefit (your spouse continues to receive payments if you die first) or a cost-of-living adjustment (your payment increases each year to keep up with inflation). Each option reduces your monthly payment but adds protection.

Ask each insurance company for the surrender charge schedule — the penalties you would pay if you needed to withdraw money in the early years. Ask whether the monthly payment is fixed or variable. Ask what happens to your money if you die before you have collected the full amount you invested. These details matter, and they vary significantly between companies and products.

Questions to answer before you buy

Before you commit to an annuity, sit down and answer these questions honestly. If you cannot answer yes to most of them, an annuity is probably not the right choice.

First: Do you have a genuine gap between your may provide income and your expected expenses? If Social Security and a pension already cover your basic costs, an annuity is unnecessary. Second: Can you afford to lock this money away for at least five to ten years without needing it? If you have significant medical expenses ahead or you are not sure, do not buy an annuity. Third: Do you have an emergency fund separate from the money you are considering for an annuity? If this is your only savings, keep it liquid. Fourth: Have you compared quotes from at least three insurance companies? If you have not, you do not yet know whether the price is fair. Fifth: Do you understand the contract you are signing? If the terms are unclear, ask questions until they are clear, or walk away.

Alternatives to consider

An annuity is not the only way to create may provide income in retirement. Depending on your situation, other options may work better.

If you have not yet claimed Social Security, delaying your claim by a few years increases your monthly benefit significantly — roughly 8 percent per year from age 62 to age 70. This is a form of may provide income increase that costs nothing and requires no insurance company. If you have a pension, you may have the option to take a lump sum or receive monthly payments. The monthly payment option is similar to an annuity and may offer better terms because your employer is backing it rather than an insurance company.

If you want some may provide income but do not want to lock up all your savings, you can buy a partial annuity — convert only part of your savings into monthly payments and keep the rest invested or in savings. This gives you both may provide income and flexibility. You can also wait to buy an annuity until you are older, when the monthly payments are higher and you have a clearer picture of your health and life expectancy.

The cost of an annuity and how it affects your payment

Every annuity comes with costs. The insurance company charges fees to manage the contract, cover their overhead, and build in their profit. These costs reduce the monthly payment you receive, sometimes significantly.

A straightforward when ready annuity — where you hand over a lump sum and receive a fixed monthly payment for life — typically has lower costs than a variable annuity or a deferred annuity with riders. The difference can be 1 to 3 percent per year, which compounds over time. On a $300,000 annuity, a 1 percent difference in costs means roughly $3,000 per year in lost income, or $60,000 over 20 years.

When you get a quote, ask the insurance company to break down all costs and fees in writing. Ask what percentage of your payment goes to the insurance company's costs versus what goes into your monthly check. Compare this across companies. A slightly lower monthly payment from one company might actually be a better deal if the costs are lower and the contract is simpler.

Frequently Asked Questions

What if I buy an annuity and then need the money?

You can withdraw money, but you will pay a penalty. Most annuities charge a surrender fee of 5 to 10 percent of the withdrawal amount in the first five to ten years, plus income taxes on the earnings portion. After the surrender period ends, you can usually withdraw without penalty, but you still owe income taxes. Some annuities allow a small annual withdrawal (often 10 percent) without penalty.

Can I buy an annuity with money in my IRA or 401(k)?

Yes. You can roll money from a retirement account into an annuity, and the transaction is not taxed as long as it goes directly from one account to the other. However, when you eventually receive payments from the annuity, those payments are taxed as ordinary income. Consult a tax professional before you do this, because the rules vary depending on the type of account.

What happens to my annuity if the insurance company goes out of business?

Each state has a guaranty fund 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 your state's guaranty fund rules and verify that the insurance company is licensed and rated as financially stable by agencies like AM Best.

Is an annuity a good investment?

An annuity is not an investment in the traditional sense — you are not buying something that will grow in value. You are buying insurance against the risk of running out of money. Whether it is a good choice depends on your personal situation, not on whether the stock market is up or down. If you need may provide income and can afford to lock the money away, it may be right for you. If you do not need may provide income or you cannot afford to lose access to the money, it is not.

Should I buy an annuity from the same company that manages my investments?

Not necessarily. Shop around with multiple insurance companies, not just the company you already do business with. Insurance companies that specialize in annuities often offer better rates than banks or investment firms that sell annuities as a side product. Get at least three quotes before you decide.