Annuity or Stay Invested? How to Think About Your Savings

You have done the hard work of saving, and now it feels like you are being asked to pick a side. One person tells you to keep everything invested and let it grow. Someone else tells you to lock in an income you can never outlive. Both sound sure of themselves.

I am Bradley Stone, an independent agent here in Central Florida, and this question comes up at nearly every retirement conversation I have. The honest answer is that it is rarely all or nothing. The better question is what job each part of your money needs to do, and whether a portion of your savings would do that job better inside an annuity or left right where it is. This article walks through how to think about that, including the situations where staying invested is clearly the better choice.

Two different tools for two different jobs

If you have not read my plain overview of how annuities turn savings into income, it covers the basics of fixed and indexed annuities. This article goes a step further.

Money that stays invested, whether in a 401k, an IRA, or a regular brokerage account, is built for growth and flexibility. Its value rises and falls with the markets. You can usually get to it when you want it, and you carry all of the ups and downs yourself.

An annuity is a contract with an insurance company. You give up some access to your money and some of its growth potential, and in exchange the insurance company makes contractual promises, such as protecting your principal from market losses or paying you income for the rest of your life. Those promises are backed by the claims paying ability of the company that issues the contract, which is why the strength of that company matters.

Neither tool is better in general. They are built for different jobs, and most retirement plans have more than one job to do.

What staying invested does well

Keeping your money invested has real strengths, and any honest comparison should start there.

• Access. You can generally sell and get your money when you need it, without a surrender schedule. The catch is that you may have to sell at a low price if the market happens to be down that month.
• Growth potential. Over long stretches, invested money has the potential to grow faster than inflation. There is no promise it will, and there can be painful years along the way.
• Flexibility. You can change course, spend more one year and less the next, or move money as your life changes.
• Legacy. Under federal tax rules, many investments your heirs inherit get a new cost basis equal to their value on the date of your death, which can wipe out the taxable gain that built up during your lifetime.
• Tax treatment in a regular brokerage account. Long term capital gains there can be taxed at lower rates than ordinary income. Money in a traditional IRA or 401k is a different story, since withdrawals are generally taxed as ordinary income either way.

The weakness is just as clear. There is no floor. If you are drawing income during a bad stretch, you are selling while prices are down, and you carry the full risk of living longer than your money lasts.

What an annuity does well

A fixed or indexed annuity solves a different set of problems.

• Income for life. An annuity can pay you income for as long as you live, no matter how long that turns out to be. Very few other tools can make that promise.
• Protection from market losses. Fixed and indexed annuities do not lose value when the market drops. With an indexed annuity, a down year typically means you are credited nothing rather than losing money, although surrender charges and rider fees can still reduce what you walk away with.
• Tax deferral on money outside retirement accounts. Growth inside an annuity bought with money that has already been taxed is not taxed until you take it out.
• Florida creditor protection. Florida Statute 222.14 protects the proceeds of annuity contracts issued to Florida residents from most creditors.
• A steadier mind. A predictable check can make it easier to leave the rest of your savings alone during a rough market instead of selling in a panic.

Two of those points deserve an honest footnote. If the money is already inside an IRA or 401k, it is already tax deferred, so an annuity adds no extra tax deferral. And Florida Statute 222.21 already protects most retirement accounts from creditors, so creditor protection is not a reason by itself to move IRA money into an annuity.

What you give up with an annuity

This is the part that gets rushed in too many sales conversations, so I want to slow down here.

Surrender periods. Most deferred annuities charge a fee if you take out more than a set amount during the first several years. Many contracts let you withdraw a limited amount each year without a charge, and you should know exactly how much. Florida law helps here. For most annuities sold to someone 65 or older, Florida caps the surrender charge at 10 percent of the amount withdrawn and requires the charge to be gone after the tenth policy year. That is a ceiling, not a typical number, and many contracts are shorter.

Limits on growth. An indexed annuity protects you from losses, but it also limits your gains through caps, participation rates, or spreads. In a strong market year, your money in the market could grow far more than the amount credited to the annuity. Ask whether the company can change those limits after the first year, because many can.

Rider costs. Optional income riders and other features usually carry an annual charge that reduces your contract value. Sometimes they are worth it, but you should know the cost in plain terms first.

Taxes on the way out. Gains inside an annuity are taxed as ordinary income when you withdraw them, not at capital gains rates. With an annuity bought outside a retirement account, withdrawals before the income phase come out of earnings first, so the taxable part comes out before your original money does. If you are under 59 and a half, the IRS generally adds a 10 percent additional tax on the taxable part, with some exceptions. Florida has no state income tax, so for Floridians this is a federal question.

Legacy. The growth inside a deferred annuity does not get that fresh cost basis at death. Your beneficiary generally owes income tax on the gain when they receive it. If leaving money to your children is a top goal, that matters.

Inflation. A fixed monthly payment buys a little less every year. Some contracts offer increasing income, but that typically means a lower starting payment.

The floor and upside idea

The way I find most useful to think about this is to split your retirement spending into two piles.

The first pile is your essential expenses, the bills that must be paid every month no matter what the market does: housing, food, utilities, insurance, and medical costs. The second pile is everything else: travel, gifts, projects around the house, helping the grandkids.

Your floor is the dependable income that covers the first pile. For most people, Social Security is the base of that floor. Some also have a pension, including many Florida teachers, deputies, and state workers in the Florida Retirement System Pension Plan, which pays a lifetime monthly benefit. Your upside is the invested savings you draw on for the second pile, for growth, and for whatever you want to leave behind.

Here is a hypothetical example, with round numbers for illustration only. Say a couple figures their essential bills at $5,000 a month and their Social Security at $3,800 a month. Their floor has a $1,200 gap. The question for them is not whether annuities are good or bad. It is whether they want that $1,200 gap covered by a contractual income, or by withdrawals from invested savings that will be larger in some years and harder in others.

Either answer can be reasonable. If you want to see how much income your savings might realistically produce, my article on how much monthly income your savings will produce walks through it.

When staying invested is clearly better

Here is when I will tell you plainly that an annuity is the wrong move.

• Your floor is already covered. If Social Security and a pension cover your essential bills, you may not need more guaranteed income at all.
• You may need the money soon. Your emergency fund, your hurricane deductible, a roof replacement, or money you plan to give a child in the next few years should not sit in a contract with surrender charges.
• Your health is a serious concern. Income that lasts for life is worth the most to people who live a long time. If your health or family history points the other way, lifetime income may be poor value for you.
• Your main goal is leaving money to heirs. If you do not expect to spend this money, the tax treatment of annuities at death often works against that goal.
• The only reasons given are tax deferral or creditor protection on IRA money. As covered above, you already have both.
• You are comfortable with market swings, you have a long time horizon, and your spending can bend in a bad year.
• Someone wants you to swap an annuity you already own for a new one. Exchanging one annuity for another can be done without current tax, but it often starts a brand new surrender period. Ask what you gain, what you pay to leave, and how long you are locked in again.
• You feel rushed. Any good decision here can wait a week.

When a portion in an annuity can make sense

A portion of savings in an annuity is worth a real look when some of these are true.

• There is a gap between your essential bills and your Social Security and pension income.
• You are single or widowed with no pension, and you worry about outliving your money.
• People in your family tend to live well into their nineties.
• A market drop right after you retire would do real damage to your plan. My article on sequence of returns risk explains why the first years of retirement are the most sensitive.
• You would like to wait to claim Social Security and need income to bridge the years until you do. See when to take Social Security for how that decision works.
• You know yourself well enough to know you would sell in a panic, and a steady check would help you leave the rest alone.

Notice that I have not given you a percentage. That is on purpose. How much, if any, belongs in an annuity comes from your own budget, your other income, and your health, not from a rule of thumb in an article.

Questions worth asking before deciding

These go a little further than the basic questions I suggest for any annuity.

• Which specific monthly bills would this income cover?
• If I needed a large sum in year three, what would it cost me in surrender charges?
• How is growth credited, and can the company change the cap or participation rate after the first year?
• What does each optional rider cost each year, and what exactly does it pay for?
• Is this money coming from an IRA or from savings I already paid tax on, and how would the withdrawals be taxed?
• What happens to the remaining value if I die early, and how would my beneficiary be taxed?
• If this replaces a contract I already own, what am I paying to leave, and does a new surrender period start?
• How strong is the insurance company behind the promise?
• What will the money I keep invested be doing, and who is helping me with that part?

Where I fit, and where I do not

I want to be clear about my role. I am a licensed insurance agent. I help people decide whether an annuity belongs in their plan, and if one does, I compare contracts from a wide range of top rated carriers to find one that fits. You can read more about the annuities I help with and why working with an independent agent matters.

Annuities are one of my products, so you deserve to know where I sit. If you move part of your savings into an annuity through me, I may be compensated. If you stay invested, I am not. I would rather tell you that plainly than have you wonder, and I will lay out both paths in writing, including the one that pays me nothing, before you sign anything.

I do not manage investments, and I do not tell anyone how to invest the money that stays in the market. If you already work with someone on that side, I am glad to work alongside them so the two halves of your plan fit together. Sometimes the most useful thing I can do is look at your numbers and tell you that you do not need an annuity at all.

Let us talk it through

If you are in Orlando, Clermont, Winter Garden, Apopka, Altamonte Springs, Lakeland, or anywhere nearby and you are trying to decide what part of your savings should do which job, I would be glad to sit down with you. We can look at your essential bills, your other income, and whether there is a gap worth covering, with no pressure and no obligation. Call 407.878.8277 or request a free quote.

This article is general education, not tax, legal, or investment advice. Your own situation deserves a personal review.