Are annuities a good investment? It depends, and here is how to tell

For some people in some situations, and for many people not at all

That is the honest answer, and the order of this page follows from it. The disadvantages come first and in detail, because they are the part most likely to be skipped in a sales conversation and because they are what determines whether the rest is even relevant to you. Then the situations where a contract genuinely earns its place, then the four types, then the questions worth asking any agent, including us. We place these contracts, which is exactly why the criticism belongs at the top.

One framing point before the detail. An annuity is not an investment in the sense a mutual fund is. It is a contract with an insurance company, and what you are buying is a promise, priced by giving up access to money. Judging it as an investment usually produces the wrong conclusion in both directions.

The real disadvantages

Surrender charges lock the money up. Deferred contracts charge a percentage on withdrawals above a free amount, for a period that commonly runs several years and sometimes far longer. The charge usually declines each year, but during the schedule your money is not fully yours in any practical sense. Ask for the schedule year by year, in the contract rather than the brochure.

Liquidity is limited even when no charge applies. The annual free withdrawal is typically a fraction of the contract value. That is fine until a roof, a diagnosis or a family emergency needs more than the fraction.

Caps and participation rates limit what an indexed contract credits. A fixed indexed annuity does not pay the index return. It pays a share of it, subject to a cap, a participation rate or a spread, and the insurer can change those at renewal within contract minimums. A strong year for the index can credit far less than the headline suggests, and dividends are excluded entirely.

Complexity favours the seller. Roll-up rates on an income base, rider fees, crediting methods and multi-year surrender schedules are difficult to compare between contracts. Difficulty is not neutral: it makes a bad contract harder to spot.

Rider fees are charged every year regardless. An optional income rider deducts its fee in years when the contract credits nothing, which is how a contract value can fall while its guarantees look intact.

The guarantee is only as strong as the insurer. Annuities are not bank deposits and are not FDIC insured. Payment depends on the issuing company's claims-paying ability, backed by limited state guaranty association protection if it fails. Our carrier evaluation guide explains how to check that yourself.

Opportunity cost. For money with a long horizon, giving up market participation to avoid volatility you have time to ride out has historically been an expensive trade. That is the core of the standard criticism and it is correct.

Regulators take this category seriously for these reasons, and consumer alerts about unsuitable annuity sales to seniors are easy to find from state authorities. That is a reasonable thing for a buyer to read before a purchase, and we would rather you read it than not.

When they genuinely make sense

Three situations, and they are narrower than the marketing suggests.

Longevity risk. A portfolio can be exhausted; a lifetime income contract cannot. For someone with no pension, adequate but not generous savings and a realistic prospect of living into their nineties, that is a risk no investment insures.

Sequence-of-returns risk at the retirement threshold. Withdrawing for living expenses during a fall in the first years of retirement permanently reduces what is left to recover. Covering the essentials from income that does not move means you are not a forced seller. Our protection page explains the mechanism, and notes that the fix is often cash rather than a contract.

A floor you will not touch. For someone who knows they will not hold a strategy through a bad year, a smaller guaranteed income they leave alone can beat a better plan they abandon.

In all three the size is the same: the gap between essential monthly expenses and income already guaranteed for life. Our income calculator measures it. If the gap is zero, none of this applies to you, and we will say so.

The four types

Variable annuities are a fifth category and a different animal: the sub-accounts are invested in the market, the product is a security, and the fees layer. We do not place them, and evaluating one requires a securities licence we do not hold.

Questions to ask any agent, including us

1. Show me the surrender charge schedule year by year, in the contract, and tell me whether a market value adjustment applies.
2. How much can I withdraw each year without a charge, and will that cover a required minimum distribution later?
3. For an indexed contract: what are the current cap, participation rate and spread, what are the contractual minimums, and what has this carrier actually renewed at on existing contracts?
4. What riders am I paying for, what does each cost per year, and what happens if I decline them?
5. What is the issuing insurer's financial strength rating, and what was it five years ago?
6. What does this look like next to doing nothing, on the same page?

An agent who answers all six without hesitation is expecting you to compare. One who does not has told you something useful.

On the standard criticism

The best-known objection to annuities, argued loudly and often, is that fees are high, the money is locked up, the products are complex and long-term growth comes from staying invested. Most of that is right, and we say so at length on our page about what that criticism gets right and wrong. The disagreement is narrow: it is about a minority of retirees with a real income gap, not about the product being broadly suitable. If you arrive already sceptical, you are starting from the more accurate position.

How we handle it

We build the income worksheet first, and if there is no gap we do not propose a product. If there is one, we size a contract to the gap and nothing more, compare carriers on financial strength, surrender terms and renewal history, and put the reasoning and the alternatives in writing before anything is signed. A recommendation to move retirement money into an annuity is covered by California's best-interest standard for annuity sales and the federal Department of Labor's PTE 2020-02, and we treat both as live. For clients 65 and over, California Insurance Code section 789.10 requires 24 hours' written notice before an in-home appointment.

Neutral background worth reading first: the California Department of Insurance's guide Annuities: What Seniors Need to Know and FINRA's annuities overview.

Questions people ask about annuities

Reviewed by Roberto Morales, California Insurance License #0G97165. Next Wave Options is licensed for life and annuity products only and does not provide investment, tax or legal advice.