Annuities generate more heat than anything else in this business. One side says they are the answer to retirement; the other says they are always a bad deal. Both are selling something.
The honest position is duller: an annuity transfers a specific risk to an insurance company. If you have that risk and want it transferred, it works. If you do not, it is an expensive way to hold money.
Ten minutes of arithmetic tells you which you are.
The gap test
Step one — total your essential monthly expenses. What you would still have to pay in a bad year: housing including taxes and insurance, utilities, food, transport, insurance premiums, out-of-pocket healthcare. Not travel, not gifts, not hobbies.
Step two — total your guaranteed monthly income. Social Security at your intended claiming age, any pension, any existing annuity income.
Step three — subtract. The difference is your income gap.
The retirement income gap calculator does this and expresses the result as a withdrawal rate against your portfolio.
What the answer means
No gap. Your guaranteed income covers your essentials. Your portfolio funds discretionary spending rather than keeping the lights on, and a poor run of markets is uncomfortable rather than dangerous. On these numbers there is no case for buying guaranteed income — and we will say so.
A modest gap at a low withdrawal rate. A portfolio handles this perfectly well for most households. An annuity is optional, and the honest reason to buy one is that you would prefer the certainty. That is a legitimate reason.
A large gap at a high withdrawal rate. Now sequence-of-returns risk deserves genuine attention, and covering part of the gap with guaranteed income is a structural decision rather than a product sale.
The same gap, two different answers
Consider a couple with $3,900 of combined Social Security and $5,200 of essential expenses. Their gap is $1,300 a month, or $15,600 a year.
- With a $750,000 portfolio, that gap is a 2.1 percent withdrawal rate. Comfortably sustainable. They probably do not need an annuity, and if they buy one it should be because they want the certainty.
- With a $300,000 portfolio, the same gap is a 5.2 percent withdrawal rate before any discretionary spending. At that level a poor opening decade is genuinely dangerous, and covering part of the gap materially improves the plan.
Same gap. Completely different answer. The arithmetic decides, not the product.
Why sequence risk is the real problem
Two retirees can experience the same average return over thirty years and end up in completely different places, purely because of the order the returns arrived in. A poor first five years while you are withdrawing depletes the capital that would have compounded in the recovery. The same five bad years at the end of retirement are largely harmless.
You cannot diversify away the order of returns. What you can do is make sure you are not forced to sell into a falling market to buy groceries.
Three contract terms to read before the brochure
Benefit base is not account value
A contract advertising a “7 percent roll-up” is not paying you 7 percent. It is growing a hypothetical benefit base used solely to calculate a future income payment. Your actual account value — the money you could withdraw or leave to a beneficiary — grows at the crediting rate, which is a different and usually much smaller number.
Both appear on the statement. Ask directly: “Which of these numbers can I take out in cash?”
Also check:
- The surrender schedule — how many years, what percentage each year. Only commit money you will not need during that period.
- The rider fee — charged annually against the account value, whether or not you ever turn the income on.
And note that guarantees are backed by the issuing insurance company’s financial strength, not by any federal agency, with state guaranty associations providing a backstop up to state-specific limits. Carrier ratings are part of the decision.
What we will not do
- Recommend putting all or most of your savings into an annuity
- Present a roll-up rate as though it were an account value return
- Skip past the surrender schedule because it is in the second half of the brochure
- Sell an annuity inside an IRA for tax deferral it does not add
If you already work with an adviser or accountant, we would rather coordinate with them than around them.
Run the numbers, then call us. A meaningful share of these conversations end with no product at all — which is exactly why we can afford to do the analysis for free.
More depth in annuities explained honestly and on the retirement income planning page.
Frequently asked questions
How much of my savings should go into an annuity?
As a general rule, no more than the amount needed to close the gap between your essential expenses and your guaranteed income — and often less. Annuities trade liquidity and growth for certainty, which is a sensible trade only for the money doing the certainty job.
What is a surrender charge?
A declining penalty applied if you withdraw more than the free withdrawal amount during the surrender period, commonly five to ten years. Only commit money you will not need during that period.
What is a roll-up rate?
A guaranteed growth rate applied to a hypothetical benefit base used to calculate future income payments — not to your actual account value. A contract advertising a 7 percent roll-up is not paying you 7 percent on withdrawable money.