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Types of Annuities to Consider for Retirement

Byline profile imageWritten by Mark Henricks
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Byline profile imageEdited by Arturo Conde, CEPF®
Byline profile imageEdited by Marie White, CEPF®
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Byline profile imageReviewed by Brandon Renfro, CFP®, RICP, EA
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Annuities can provide retirees with a guaranteed stream of income, but choosing the right type is key to making the most of these products. First, however, you must be familiar with the major features of each type of annuity so you can determine the best fit for your retirement planning. It’s also essential to assess your financial needs in retirement so you know what to look for. Finally, it is critical to assess key factors, such as fees, liquidity needs and the annuity company’s financial stability. 

Partner with a financial advisor to compare annuity choices and begin planning for your retirement.

Retirement Annuity Basics

An annuity is a contract you enter into with an insurance company. 

You buy an annuity by making either a single, lump-sum payment or through a series of smaller payments that typically last several years. In return, the insurer sends you fixed payments beginning either immediately or on a future date. Payments can last for a certain number of years or, when used for retirement, for the annuitant’s lifetime.

Annuities benefit from favorable tax treatment. When you use your savings to purchase an annuity, your savings grow tax-deferred. Upon withdrawal, you pay ordinary income tax on the portion representing earnings. Similar to 401(k) plans and other tax-advantaged retirement savings accounts, there is typically a 10% early withdrawal penalty for withdrawals before age 59 1⁄2.

In retirement planning, annuities are particularly useful for hedging against market risk and life expectancy risk. That’s because they can guarantee income for life, regardless of how long you live or how markets perform. Some annuities even continue payouts to a surviving spouse. However, you give up control over the lump sum in exchange for this security.

Retirement Annuity Choices

Annuities have many different structures that each have their own benefits and disadvantages. These three types of annuities can benefit your retirement planning in several ways

Fixed Annuities

Fixed annuities offer a minimum guaranteed interest rate for a set period, which can range from one to 30 or more years. The insurer declares a new guaranteed rate at the beginning of a new year or other period. Otherwise, fixed annuity payments remain the same over time.

Variable Annuities

Variable annuities invest your funds in different securities, such as stocks and bonds. Without a guaranteed rate of return, payouts fluctuate based on the performance of these underlying investments. 

Because of this, variable annuities generally require a higher risk tolerance, as they carry greater exposure to market risk but offer potentially higher returns than fixed annuities.

Indexed Annuities

Indexed annuities are hybrid products that provide a minimum guaranteed rate thatcarry the possibility of higher returns because they are linked to a market index like the S&P 500. Even if the index declines, your account will never earn less than the minimum rate; however, caps limit the amount of positive index performance you can access. 

Immediate vs. Deferred Annuities

These types of annuities can all vary in the timing of their payouts, depending on whether you choose immediate or deferred annuities. 

  • Immediate annuities. Immediate annuities begin payouts within 12 months of purchase.
  • Deferred annuities. Deferred annuities have an accumulation stage where funds grow tax-deferred before their eventual distribution.

Making the Right Choice

A woman making a list of questions to identify the best type of retirement annuity for her needs.

To determine which type of retirement annuity is best for you, consider these points.

  • What is your risk tolerance? Variable and indexed annuities carry some market risk, so more conservative investors may prefer fixed products.
  • What are your income needs? Consider whether you require fixed payouts that never change or whether you can bear market fluctuations. This will help guide your choice between fixed vs. variable options.
  • How long do you require income? Lifetime payout annuities often make sense for those with greater longevity expectations.
  • What are your liquidity needs? Assess whether you will require access to your lump sum in the future. Deferred annuities have longer lockup periods than immediate ones.
  • How much can you afford to invest upfront? Larger lump sums ultimately result in bigger ultimate. However, some annuities accept smaller periodic contributions.
  • What fees work best for your budget? Less affluent retirees may need to optimize their planning to accommodate lower-cost products.

The ideal product aligns with several factors, including:

  • Risk appetite
  • Age
  • Life expectancy
  • Income requirements
  • Liquidity needs
  • Investable assets
  • Tolerance for fees 

Annuities also vary in terms of fees, withdrawal options and death benefits. It can be challenging to sort through all the options, but thoroughly investigating alternatives prevents making an expensive mistake.

Retirement Annuity Limitations

Along with benefits, annuities can also present notable downsides. 

  • High fees. Insurers levy several annuity fees, including annual mortality fees, expense fees and administration charges, which is usually less than 1% of the annuity’s value . It is important to use caution so the total cost of your annuity does not seriously erode any gains made from its long-term performance.
  • Liquidity risk. If you have to withdraw funds early, you are likely to be charged surrender fees, which typically start around 7% when you cash out your annuity within the first year. Therefore, it is important to ensure your withdrawal plan aligns with your future needs.
  • Issuer instability. If the insurer or insurance company has financial troubles, your payouts may decrease or cease completely. Carefully assess an issuer’s ratings and financials beforehand.
  • Tax burdens. While funds grow tax-deferred, payouts face ordinary income tax rates up to 37% through 2026. Taxes this high can significantly eat into your net proceeds.

How to Determine If an Annuity Is a Fit for Your Retirement 

Annuities can play a useful role in retirement planning for people seeking steady income independent of the stock market. 

When you buy an annuity, you exchange part of your savings for guaranteed payments lasting either a set number of years or your lifetime. This can help cover your basic expenses and reduce the worry of running out of money in retirement.

An annuity may make sense if you already have savings in accounts like a 401(k) or IRA and now want to turn some of that money into income. It’s especially worth considering if you don’t have a pension or if most of your savings are invested in the market and you want to add something more predictable. The security of an annuity can complement other sources of income, such as Social Security or investment withdrawals.

That said, annuities aren’t for everyone. They usually come with fees, and once you commit funds, it can be hard to access the money if you need it for other purposes. It’s also important to compare the financial strength of different insurance companies. Be sure to review the annuity terms carefully to ensure you understand exactly what you’re paying for because different annuities can vary significantly in cost and features.

If you’re thinking about adding an annuity to your portfolio, first decide how much guaranteed retirement income you want and how much flexibility you need. Then compare different types of annuities, including fixed, variable and indexed, to see which one best fits your goals. 

Talking through the options with a financial professional can help you decide how an annuity might work with the rest of your retirement plan.

Bottom Line

A woman considering the benefits and drawbacks of taking out an annuity.

The right annuity product can significantly enhance retirement security through guaranteed lifetime income. However, annuities lack a one-size-fits-all approach and are available in many varieties. To pick the right one for you, research your options thoroughly before integrating annuities into your overall financial plan. Be wary of pitfalls such as high fees, and make sure the insurance company is financially sound before making your investment.

Tips for Retirement Planning

  • Consider meeting with a financial advisor to discuss whether annuities fit into your retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Use SmartAsset’s Retirement Calculator to measure your progress toward funding retirement.

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