5 Expert-Backed Reasons Annuities May Not Suit Your Retirement Plans

If you’re planning for retirement, chances are you’ve explored buying an annuity. You probably also know that annuities offer guaranteed income, and have wondered whether it’s a savvy financial move compared with an individual retirement account (IRA).

An annuity is a contract with an insurance company that provides regular payments, often for life. Annuity holders pay premiums to the company, and payouts can begin in as little as a year or after a lockup period, depending on the type of annuity.

However, if you’re not planning to retire anytime soon, they might not be the best fit for many reasons, especially when compared with an IRA.

The Hidden Trade-Off: Security Now, But Lower Growth Later

Annuities are designed to provide a steady, reliable income. Fixed annuities, for example, guarantee a consistent payout, no matter how the market performs. But that lower amount of risk could cost you potential growth, meaning you could be leaving money on the table, according to Luke Harder, a certified financial planner (CFP) at Claro Advisors.

“Many annuities place limits on upside potential,” Harder said. “For example, clients who locked into annuities a few years ago missed the strong equity market returns that an IRA invested in stocks would have captured. That ‘safety’ often comes at the cost of long-term wealth building.”

Some annuities invest your money in index funds, but in many cases, your potential gains are capped in exchange for a minimum guaranteed return.

“A fixed-index annuity might guarantee a 1% to 3% minimum return even in a down market, which sounds great—but cap the upside at around 11% to 12%, even if the portfolio delivers far more in a strong year,” said Brenna Baucum, lead planner at Collective Wealth Planning.

Annuities Come With Fees—And They’re More Complicated Than You Think

Annuities typically come with annual maintenance and operational fees that are often significantly higher than the costs associated with investing in a comparable mutual fund. If you have a variable annuity, where the insurance company invests your contributions, there’s typically a fee for that, too. 

“The main drawback of annuities is their high and often complex fees,” said Hazel Secco, CEO of Align Financial. “While the guaranteed income stream doesn’t change, the other variables—mortality charges, administrative fees, and investment sub-account costs—can erode the account balance over time. In some cases, this means there may be little or no residual value left as a death benefit if the account is depleted.”

Want to Withdraw Your Money? Good Luck

Accessing your funds early can be prohibitively expensive. Annuity contracts typically lock up your money for a period of seven to 10 years, with steep surrender charges for early withdrawals. 

Marguerita Cheng, CEO of Blue Ocean Global Wealth, had a client with an annuity whose husband was diagnosed with Parkinson’s disease. They would’ve had to pay a significant fee to withdraw money for his care, Cheng said, so they liquidated some of their IRAs instead.

Some annuities provide exceptions for chronic medical care, but they often have extra fees ranging from 0.25% to 1.5%, Cheng said.

Annuities Can Complicate Passing Wealth to Your Heirs

The trade-off of many annuities derives from the fact that the insurance company has to keep making regular payments, even if the annuity holder lives to the ripe age of 120 and beyond. However, if the client dies while there’s still money left in the account, those funds typically belong to the company. 

Baucum said one of her clients, an 82-year-old woman, had spent almost 15 years “methodically liquidating her annuity” to make things simpler for her heirs. 

“It’s no surprise that many clients I meet are actively trying to get out of them,” Baucum said. 

Your Advisor Might Not Tell You This: Annuities Often Come With Big Commissions

Much like the administrative fees, the commissions for selling annuities are typically much higher than those for a mutual fund or shares in an exchange-traded fund. 

For example, if an investor rolls their 401(k) into an IRA that invests in mutual funds, a financial advisor might make a commission of 1%. A variable annuity that invests in the same mutual funds can come with a commission of 6% to 8%, if not higher.

“Annuities are tricky because most are sold from commissioned agents,” said Robert Persichitte, CFP at Delagify. “You should never buy an annuity without getting a second opinion.”

The Bottom Line

Annuities can provide a dependable stream of income that retirees can count on for the rest of their lives. IRAs and 401(k)s do not. For some, that’s the right financial decision. But the cost of that stability can be higher fees, reduced upside potential, and a complex structure that can leave you struggling to access your money if you don’t fully understand what you’re signing up for. 

Consider whether an annuity suits your financial needs better than an IRA. And, as Persichitte suggests, it’s always good to get a second opinion.