Annuities in Retirement: Pros and Cons of Annuities

What is an annuity?

An annuity is a contract between you and an insurance company in which the insurance company makes a series of regular payments to you in return for a premium(s) you have paid. Some annuities may allow you to withdraw a portion or all your accumulated earnings before payments begin. Annuities differ from life insurance in two important ways. There's no medical underwriting involved in an Amica annuity contract, and your annuity can start making payments before your death.

For example, with a deferred annuity, you start with either one lump sum payment or make periodic payments, which accumulate tax-deferred earnings until you begin withdrawals or convert the policy to a stream of income. For Roth funds, earnings are usually tax-free, as long as withdrawals occur after 59½.  

Another option is an immediate annuity, allowing you to convert a lump sum contribution into payments that start within the first year or as soon as 30 days, depending on your contract, which is helpful for those close to or already in retirement. 

How are annuity payments calculated?

Insurance companies rely on payout rates to calculate payments for most annuities. The payout rate will tell what percentage of your premium you’ll receive each year. Payout rates are based on the age and gender of the person the payments are based on and also the annuity option you select. Each contract will have a set of guaranteed minimum payout rates and companies may provide higher rates depending on their current immediate annuity rates.

Like any important decision, it’s beneficial to weigh the pros and cons of an annuity. 

Pros of annuities

Fixed interest rates

For those who value stability, the benefits of fixed interest rates are undeniable. You can avoid volatile market swings with a competitive, fixed interest rate. And while you’re contributing, your interest rate will never go below a specified minimum. Your rate will stay fixed for a period of time, typically one year or more, depending on the type of contract you choose.

Guaranteed lifetime income

An annuity can help remove the worry about outspending your savings in retirement by providing a guaranteed income stream regardless of market performance. Some annuities may offer a life contingent option, which can help ensure you won't outlive the guaranteed payments.

Tax-deferred growth

With an annuity, there are fewer limits on contributions than with a 401(k) or IRA. Deferred annuities allow you to grow your savings over time without paying taxes on the interest until withdrawal.

Flexible payment options

From deferred annuities to immediate, there are different annuity options to suit your needs. With a deferred annuity, you can choose to take some or all of your account earnings in ad-hoc withdrawals, instead of receiving income over time with fixed payments. An immediate annuity will start making payments within the first year or as soon as 30 days. 

Depending on your annuity contract, you’ll be able to choose when and how to receive your payments: monthly, quarterly, semiannually or annually.

Death benefits and legacy considerations

Similar to life insurance coverage, annuities also allow you to leave a legacy for your family after your death. Your beneficiaries will be able to receive regular payments or a lump sum payment from your annuity based on the terms of your contract. You’re not limited to family; you can also leave your money to a charity or nonprofit organization.

While there are countless annuity benefits that can be essential to a successful retirement, you should also be aware of some of the risks before you decide to purchase an annuity.

Cons of annuities

Fees and charges

All annuities will have some type of fee so understanding the cost of an annuity may help decide whether or not it is the right option for you.

• Administration fees and mortality expenses: Your carriers will likely charge a fee for managing your annuity and taking on the risk of your contract. These fees and expenses usually stay below 1.5% of your contract for variable annuities. Any underlying investment funds in a variable annuity, as well as some optional riders, usually have their own fees. Unlike other carriers, Amica annuities don't come with any administrative fees or charges.
  
• Surrender charges: You may be penalized if you withdraw money from your annuity before the end of the contract. If you do, it's important to note the surrender fees will be spread out for the duration of the contract, with the highest fees being assessed at the time of withdrawal and then decreasing as the contract matures. ¹
  

Lack of liquidity

Annuities require an investment to get started. Whether you’re contributing a lump sum or making small deposits, the liquidity of your assets will matter when it comes to opening or investing in an annuity. Compared with other investment options like money market funds, mutual funds, or bonds, annuities tend to be less liquid and may prevent you from being able to manage unexpected expenses prior to your withdrawal period.

Potential for lower returns

While a fixed annuity may offer more stability, there may be less opportunity for growth. If your rate is fixed, you’re unable to benefit from rising interest rates during the period of time you’re locked into a given term.

Tax implications upon withdrawal

Your investment will grow tax-deferred before the withdrawal period. Once you start receiving payments, it may be taxed as ordinary income. If you’re in a position where you need to take out a portion of the money in your annuity before the withdrawal period, you may be subject to a 10% income tax penalty if you’re younger than 59½.

Potential for company bankruptcy

The financial stability of your provider may affect your annuity if the insurance company declares bankruptcy or becomes insolvent. At Amica, we’ve earned a financial strength rating of A+ (Superior) from AM Best, a leading insurance rating agency and the nation’s authority on insurance company financial stability.²