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Annuities 201: Do They Belong In Your Financial Plan?

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annuitiesAnnuities are some of the most heavily marketed investment vehicles available. And as I said in Annuities 101, annuities are neither good or bad.  It depends on what your financial goal is. Once you set the financial goal, you’ll be able to determine if an annuity is right for you. Since I can’t know your specific goals, this article will look at some general considerations when deciding if an annuity is the right tool for you. I’ll look at annuities in the accumulation phase and the distribution phase. Shall we begin?


  • Tax-Deferred Income. Annuities are insurance products. As such, the cash value inside of an annuity accumulates tax-deferred. When income is withdrawn from an annuity it is treated as ordinary income. Like other tax-advantaged accounts, withdrawals prior to age 59 1/2 may be subject to additional tax penalties.
  • Insurance Expenses. Unlike Mutual Funds or Exchange Traded Funds (ETF), annuities also have expenses for insurance (called mortality fees) in case they have to pay a death benefit. That expense can be in excess of 1%.
  • Administration Fees. Like Mutual Funds and ETFs, annuities have expenses to administer the accounts. Depending on the type of fund you are comparing it too, the annuity may have similar or greater administrative expenses.
  • Penalties. Annuities have penalties if you withdraw your funds before a certain number of years (typically 5-8 years). The penalty generally decreases throughout the time period.
  • “Guaranteed” Returns. Fixed annuities pay a guaranteed interest rate. Some variable annuities may offer a guaranteed return, IF the withdrawal is annuitized (taken out as a series of substantially equal payments).
  • Uses in Your Plan. Tax deferral can be accomplished with IRAs or Qualified Retirement Plans through your employer. Generally speaking these types of accounts have much lower expenses than annuities so prior to using an annuity in your plan for tax deferral max out the lower cost options first. If you are extremely risk averse, you might consider using a variable annuity with a guaranteed return to go for higher risk returns and still sleep at night. You will pay for this option though. But, when compared with losing over time to inflation, it may be worth the expense.


  • Lifetime Income. An annuity can provide a constant flow of income for as long as you (or as long as you and your spouse) live. The income can be a fixed amount, a variable amount based on investment return, or it can be indexed to inflation as well.
  • Minimum Expense Coverage. One use of annuities is to make sure that you have a source of income (inflation adjusted) for as long as you live that covers what you consider the minimum essential requirements to live. This way you shift investment return, inflation and longevity risk to the insurer. This will probably help you weather market ups and downs with less stress.
  • Longevity Insurance. There are annuities that “kick in” at around age 80. The concept is that you invest a lump sum when you retire and if you live a long life, you will start receiving additional income. This may allow you to spend a little more of your nest egg in early retirement or keep your withdrawal from your savings consistent if the market has a down year.
  • Use in Your Plan. If you retire from the military you may already have three sources of annuitized income (military retirement, VA disability and Social Security), so an annuity may not make sense for your. For those who do not retire from the military, then you may want to look at you Social Security + VA Disability + Pension from Civilian Job (if you have one) and see if the total is greater than your minimum quality of life amount. If not, then purchasing an immediate annuity when you retire may make sense. One note of caution though…You don’t want to put all of your money into an annuity. If you have a large expense such as a big medical bill and all of your money is in annuities you won’t have a good source to pay for the expense. You’ll probably have to use your credit cards or home equity.

To wrap up, annuities can be an effective tool in your financial plan. As mentioned though, they are heavily marketed and they can provide very handsome commissions to those who sell them. If someone mentions that you need annuities, start with the goal and see if the annuity is the right tool for you.


Curt Sheldon, EA is a Fee-Only Financial Planner and Enrolled Agent based in Northern Virginia.  He can be contacted at (703)542-4000, (800)928-1820 or www.CLSheldon.com

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication

The information contained in this blog is for general financial education and should not be construed as individual financial advice.  Please consult your own financial, tax or legal advisor prior to applying any principles discussed here to your own financial situation.