by Andrea Norris-McKnight

Not sure what annuities are or how they work, much less if you should include them in retirement investments? We get unbiased answers from an expert.

As you’re looking over your retirement investment options, you may have wondered about annuities. But maybe you’re still a little unfamiliar with annuities. Do you know what they are and how they work? And should you include annuities in retirement investments?

To help us out, we reached out to Brian Carlton, CFP at HSC Wealth Advisors. Here’s what he had to say:

Q: What exactly are annuities?

Mr. Carlton: Annuities are tax deferred investment vehicles sold by insurance companies. Money is contributed in one lump sum or over a period of time and it grows tax-deferred (meaning it is not taxed until taken out). In the future, the person may “annuitize” the money, which means they “give” the money to the insurance company and the company promises to pay the person a certain amount per month for the rest of their lives or it could be for the joint life of the person and his/her spouse.

Q: Why would someone choose an annuity over another type of investment?

Mr. Carlton: Generally, I do not recommend annuities for people. The simple reason is that they are expensive investment vehicles. Most annuities have administration fees, sub account fees, and surrender charges that can last for anywhere from four to ten years. A surrender charge means that if you want to take your money out, the company will charge a fee. Besides, there are thousands of salespeople out here that are trying to get you to buy one because then they reap a commission.

If someone is working and has maximized their Roth IRA and their retirement plan at work each year, then I might suggest an annuity. At that point, I suggest people look at low-expense annuity providers like Jefferson National, Vanguard, Fidelity, or Charles Schwab. It is much less expensive to open a mutual fund account. When it comes to retirement, I usually recommend that people maximize their US Government annuity that is their Social Security retirement benefit and forget about buying an annuity.

Q: What are the different types of annuities?

Mr. Carlton: There are two main types. First, there are fixed annuities in which the person earns a stated interest rate over the life of the annuity like 2 or 3% per year. There are also variable annuities in which the person invests in sub accounts, which are like mutual funds. Therefore, the return varies with the stock market.

Q: What makes an annuity a good choice for some investors, but a not-so-good choice for others?

Mr. Carlton: It is rarely a good choice unless they have maximized their savings as stated in number two above.

Q: What are some things investors tend to forget when they decide to invest in annuities?

Mr. Carlton: An important thing to remember is that when money starts coming out of an annuity, it is taxed as income. If your money is invested in a regular taxable account and you withdraw it, any gain on the investment (sold for a higher price than what you paid for it) will be taxed at capital gains tax rates (currently 0% to 20% depending on your tax bracket). So, income tax rates can be higher than capital gain tax rates.

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Reviewed August 2022

About the Expert

Brian Carlton is a CFP and a registered Investment Advisor with HSC Wealth Advisors in Forest, VA.