When Are Annuities a Good Investment?

A couple talking to financial advisor in living room
••• Hero Images/Getty Images

Annuities are a good investment if you are buying them for the right reasons.

You can buy annuities for safety, long-term growth, or income. For example, a fixed annuity might make an attractive alternative to a CD; a variable annuity might be bought for long-term, tax-deferred growth; and an immediate annuity is bought for income purposes. In each of these cases, the insurance company that issues the annuity is ensuring some portion of the outcome. In many cases, they are ensuring the amount of income you can take from the annuity in the future.

The only real way to determine if an annuity is a good investment for you is to have a plan. Your plan should dictate what your investment goals are and show you how to make choices that help you accomplish those goals. If you want to ensure part of the outcome, an annuity might be a good choice.

When an Annuity Is a Good Investment

First and foremost, an annuity is an insurance product, which means you buy it to reduce risk. Some annuities, like variable annuities, have a selection of stock and bond portfolios available as investment choices inside the insurance contract. Other annuities are true insurance with no investment component at all.

There is one thing an annuity does well, which is to provide a hedge against longevity risk (the risk of living far longer than you thought you would). If you are buying it for that reason, an annuity can be a good investment.

An annuity might be the perfect investment choice for you if you know your retirement goals, can see how the annuity helps you accomplish those goals, and understand all the fees and restrictions of the annuity product you are considering. You should understand how the annuity income is taxed when payout begins, what investment options are available, and how the annuity complements other investments you have.

When an Annuity Is Not a Good Investment

If someone is trying to sell you an annuity without looking at your entire financial picture, be cautious. Many people selling annuities mean well, but they may not have a thorough understanding of the products they are selling. They may not have a good grasp on the tax implications, and if they haven't done any planning for you, they can't see how that product is going to fit into your retirement picture.

You also want to be aware of the fees associated with the annuity because high fees lower your return. High fees in some variable annuity products mean that in anything but the best markets, your annuity investment will earn low returns.

Don’t buy an annuity unless you have crafted a plan and understand how the annuity fits in. Annuities are not going away, so there should be no pressure or sense of urgency to buy until you’ve done your homework. Some sales representatives will tell you that an annuity product is only going to be available for a short period, which may be true because insurance companies will discontinue products from time to time. However, you shouldn't worry because a similar product with similar features will likely soon pop up in place of the old one.

All Annuities Are Not Alike

There are many different types of annuities, and each has pros and cons. Once you understand the different categories of annuities, you’ll know what questions to ask about the particular annuity you might be considering.

Compare broker-sold annuities to no-load annuities before you buy. Broker-sold annuities are sold by someone who carries an insurance license and possibly a securities license too. You buy no-load annuities directly. They have lower fees, but you must do your homework and research. That is the trade-off for paying lower fees. Some fee-only financial advisors will also help you select an appropriate no-load annuity if it fits in with your plan.

Do your homework and read up on alternatives to annuities before making a final decision. You’ll also want to feel comfortable asking about annuity fees. Any reputable advisor or company should explain all costs to you before you buy. If someone is unwilling to take the time to explain the fees in their product or explain to you how they are compensated for the sale of that product, then don’t buy from them.

Bottom line: An annuity can be a good investment if it is part of a well-structured retirement income plan, and you understand what it does for you and why you are buying it.