Pros and Cons of Using an Annuity for Retirement Income

Find out from Money Girl what an annuity is, and the pros and cons of using one for retirement income.

Laura Adams, MBA
7-minute read
Episode #370

What Is an Annuity Rider?

Other features of annuities that you should be familiar with are optional benefits called riders. Just like you can add a rider to a home insurance policy to protect valuable jewelry, you can add a rider to an annuity and receive additional value above the standard contract.

Here are some common annuity riders:

  • Income rider: provides guaranteed income for a certain period of time that you can turn on in the future. This is a popular option for retirees who want to make sure that they don’t run out of money during their lifetime. I’ll give you an example of how this works in a moment.  
  • Death benefit rider: ensures that if you die, your beneficiary will receive the balance of your annuity—not the insurance company. For example, if you purchase an annuity for $100,000, but die after receiving only $20,000 in distributions, your beneficiary would receive the balance of $80,000.  
  • Nursing home rider: helps pay for expensive long-term care, either in a nursing facility or at home. For instance, it may double your monthly income, or allow you to withdraw more of your annuity balance to cover your added costs.  
  • Terminal illness rider: allows you to access some or all of your annuity balance, without having to pay early withdrawal fees or surrender penalties, if you’re diagnosed with a terminal illness that reduces your life expectancy. I’ll tell you more about surrender charges coming up.

It’s important to remember that adding a rider to an annuity gives you extra financial protection, but it comes with a cost, because it reduces the amount of income you’ll receive.

See also: Annuity Riders Protect Aging Seniors

3 Pros of Using a Fixed Annuity for Retirement Income

To know whether an annuity is right for your circumstances, weigh the pros and cons carefully, and seek advice from an annuity professional who can answer your questions.

Pro #1: Principal Protection

When you purchase a fixed annuity, the money you put in is completely safe. The worst-case scenario is a lower-than-expected return, never a loss of your principal. Even if the insurance company goes out of business, every state has a guarantee association that gives policyholders a certain amount of protection. It varies by state, but generally ranges between $150,000 and $300,000.

One of the most unique features of an annuity is the option to receive lifetime income. 

Pro #2: Guaranteed Income

One of the most unique features of an annuity is the option to receive lifetime income. Here’s a rough example:

Let’s say you purchase a $100,000 annuity with an 8% income rider at age 60. If you want to begin taking income at age 70, you’d receive approximately $1,000 per month for the rest of your life. If you live another 20 years, your $100,000 annuity would pay out $240,000 ($1,000 x 12 months x 20 years) over your lifetime. That’s a terrific return that you’re not likely to get from a typical investment, such as a mutual fund. But if you only live 5 years, the annuity company gets the better deal.

Pro #3: Tax Deferred Growth

The growth in your annuity is tax deferred, similar to the way earnings are handled within a retirement account, such as a traditional IRA or 401(k). That means your money compounds year after year, and you don’t receive a tax bill until you take withdrawals.

Additionally, when you receive an annuitized income stream, the payment is a combination of earnings and principal. Since your principal was put in on an after-tax basis, that portion is never taxable. You’ll owe tax on the earnings portion only of your withdrawals.

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About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.