As you start to research various retirement investment tools and vehicles, you might come across lifetime annuities. A quick summary makes them seem ideal: you buy a policy from an insurance company to guarantee an income during retirement, regardless of how long you live. It’s important, however, to read the fine print and look beyond glossy brochures—like any investment instrument, lifetime annuities come with their own drawbacks. Learn how they work and weigh the pros and cons before committing to this product.

What a Lifetime Annuity?

A lifetime annuity is a type of investment that’s sometimes misclassified as a type of insurance. An annuity pays you income later in exchange for making regular payments now. It’s often seen as a way to guarantee income after retirement.

If you purchase a lifetime annuity today, while you’re still working, you’ll pay into the policy for a specific period of time, known as the term. Typically at a preapproved point, you’ll stop making payments and begin receiving income. The premium-payment phase of an annuity is called the accumulation phase, while the second phase is known as the distribution phase.

You may be asking what is a life annuity because you’re considering purchasing one. If so, be very cautious about the company selling it to you. Annuity fraud has become prevalent. You should also read the fine print and compare what you’re getting to other options. Annuities are contracts that can carry additional fees and penalties depending on the annuity’s contractual terms. It’s crucial to compare the reputation of the annuity company as well as the fees and the returns you’ll get to what you’d see if you invested the funds.

How Does a Lifetime Annuity Work?

Lifetime annuities are contracts sold by insurance companies. Annuities are appealing to buyers because they guarantee a certain amount of income during your retirement and until you die, taking some of the guesswork out of retirement investing.

Here’s a quick breakdown of how annuities work: Buyers pay the insurance company either a lump sum (for a single-premium annuity) or a series of payments (for a multiple-premium annuity). The insurer then guarantees to provide the buyer (as well as their spouse, if it is a joint/survivor annuity) an income for life starting at a predetermined date, no matter how long they live.

The money invested in an annuity grows tax-deferred, so buyers won’t owe taxes on investment gains or interest on the annuity until the payments begin.

Once the buyer (or their survivor) dies, the insurance company stops payment and keeps the remainder of the premium. There are some exceptions to this: some annuities have a return-of-premium benefit that pays the annuity owner’s heirs leftover money from the original premium.

The income from a lifetime annuity is paid monthly, quarterly, or annually. The older the buyer is when they start their payouts, the higher the income will be as their life expectancy is shorter.

Types of Lifetime Annuities

Before buying an annuity, you should understand the different types of annuities that exist—they vary depending on when you want to start receiving payments and the level of risk you’re comfortable with.

Immediate Lifetime Annuities

Immediate annuities allow the owner to begin their income payouts right away. The amount of the payout can be fixed or life or have a COLA (cost-of-living) adjustment provision to hedge against inflation. There are also immediate variable annuities that determine a portion of the payout on the performance of investment instruments such as bonds, stocks, and mutual funds.

Deferred Lifetime Annuities

With deferred annuities, the income stream starts at an agreed-upon point in the future. Prior to this, the annuity sits in an “accumulation phase” and can grow in value, resulting in higher payouts than with an immediate annuity.

Fixed Lifetime Annuities

Fixed annuities have a fixed interest rate, paying a steady stream of income to the annuity owner. These are beneficial if you seek a consistent income during retirement, and want stability.

Variable Lifetime Annuities

Different from fixed lifetime annuities, variable annuities will pay returns based on the investments attached to the annuity. The owner of the annuity typically selects these investments, which are often mutual funds. While variable annuities carry some risk, it’s possible that they will generate higher returns. When the payout phase starts, the annuity owner can often choose between fixed payments or variable payments based on the continued performance of the investments.

Qualified Longevity Annuity Contract (QLAC)

A qualified longevity annuity contract (or QLAC) is a type of deferred annuity. It is purchased with funds from a qualified retirement plan or individual retirement account (IRA). QLACs offer monthly payments until the owner dies, and are exempt from required minimum distribution (RMD) rules. There are caps on how much an individual can spend from their retirement savings to buy a QLAC—in 2024, the maximum is $200,000.

Hybrid Annuities

In addition to fixed and variable annuities, there are hybrid annuities which allow the annuity owner to split their money between a fixed annuity and a variable annuity. A portion of the investment is allocated to a mutual fund sub-account; this is the variable unit. The remainder is kept separate, as a fixed annuity, to guarantee a specific payment during retirement.

Benefits of a Lifetime Annuity

If you’re weighing a life only annuity against another investment type, such as playing the stock market or putting money into an IRA, it’s important to note a few benefits of a lifetime annuity

Guaranteed Lifetime Income

The main draw of a lifetime annuity is the guaranteed lifetime income. The insurance company must pay you the income it promised, regardless of how long you life. That said, not all insurers come with financial stability—be sure that you purchase your annuity from a company that has high ratings for financial strength from the independent ratings agencies, such as Moody’s, A.M. Best, Fitch, and Standard & Poor’s.

Regular Payments

Pensions have largely gone out of fashion, so annuities can offer the same predictable monthly income that one would have gotten from a pension. This makes it easier to budget and plan for the future in retirement.

Customizable Investment

Many retirees want to be assured that their money will outlive them and continue to support their loved ones. Annuities can be modified and adapted to match a buyer’s needs, allowing for death benefit provisions that give the owner’s heirs some money after the annuity owner dies. A joint and survivor annuity can provide income for a surviving spouse. Provisions such as these do cost more upfront money, however.

Drawbacks of a Lifetime Annuity

Everything has its drawbacks. An annuity is one of many financial products for retirement, and like the others, has its share of drawbacks in addition to benefits.

Fees, Commissions, and Other Charges

Not all annuities come with fees, but some do—usually 2% to 3% per year, higher than what you might find with other investment types. These can be administrative fees, fees to cover lost income in case the annuity holder dies before the seller’s estimate (known as a “mortality risk charge”), or something else entirely. Be sure to read the annuity contract in full and understand how much, per year, you’ll be spending on fees. You should also be aware that since annuities are sold by insurance agents, some have commission fees attached to them, often 7% or higher.

Expensive Riders

All of the special options that make annuities compelling don’t come for free. Adding your spouse or another beneficiary, for instance, often means an added rider with fees. Along with the aforementioned fees and commission charges, these riders and provisions can quickly chip away at your investment.

Lack of Liquidity

While many annuities allow owners to take out a portion of their money—typically 10% each year—without paying what’s known as a surrender charge during the surrender period (typically six to eight years), if the withdrawal happens before the owner turns 59 ½, they can expect to pay income tax in addition to a 10% income tax penalty. Moreover, it’s likely that the provisions of the annuity don’t allow you to pull out your money in full after purchase. Once you commit, you commit.

Scams and Unscrupulous Sellers

Because annuity sales are commission-based, there are lots of bad actors out there looking to make a quick buck while selling a bad product or one that includes high fees.

Fluctuating Returns

With a variable annuity, the cash value can rise and fall depending on the market’s performance. When the rate falls, it could be lower than other retirement investments, and with your annuity money locked in, there isn’t much you can do.

How to Buy a Lifetime Annuity

Because lifetime annuities are a specialty product, you should consult a Financial Advisor to help you make a sound purchase of one with low fees and the kind of customization and risk level you need.

Steps to Purchasing a Lifetime Annuity

Talk to your Financial Advisor to understand how the annuity will fit into your retirement portfolio and your financial goals.

1. Talk to your Financial Advisor to understand how the annuity will fit into your retirement portfolio and your financial goals.
2. Choose an annuity that matches with your financial goals.
3. Select an annuity company; some of the major sellers include Allianz, New York Life, Nationwide and Prudential.
4. Submit your application; before you sign and hand over your money, go over all the fees and commissions associated with the purchase, ideally with the help of a Financial Advisor.

How to Choose an Annuity Provider

With all the annuity scams out there, it’s important to choose a sound, stable, well-known insurance company. Here are some tips to help you find the best annuity company for you.

• Look at ratings: J.D. Power’s website has ratings of insurance companies, assessed by customer satisfaction.
• Evaluate financial stability: Third-party agencies such as AM Best, Standard & Poor’s (S&P) or Moody’s offer ratings on insurance companies’ financial strength. It’s critical to choose a company that is secure and will be around for the rest of your life.
• Get quotes: There’s no need to pick the first company that sends you a quote. Get quotes from several insurers to review the rates, riders, fees, and more. Being equipped with multiple offers also gives you negotiating power.
• Talk to an advisor: Speak with a trusted, fee-only Financial Advisor to get advice on the best companies for annuities. Some insurance agents might refer to themselves as advisors, but since they will receive a commission on the product they sell you, they might not have your best interest at heart.

How to Calculate Your Lifetime Annuity

Before purchasing a lifetime income annuity, it’s important to understand how to estimate your future payouts and compare different options. While there are many online annuity calculators available, knowing how to do a manual calculation can give you a clearer understanding of how each annuity plan measures up.

Step 1: Gather Key Information

To estimate the value of a lifetime annuity, you’ll need the following data:

• Initial investment amount: The starting balance of the annuity.
• Annual contributions: How much you plan to add to the annuity each year.
• Investment period: The total number of years you’ll contribute to the annuity.
• Interest rate: The fixed or variable rate of return offered by the annuity provider.

Step 2: Calculate the Future Value

Using these inputs, you can project the future value of the annuity over time. Start by calculating the annuity’s balance at the end of each year:

• Year One: Add your initial investment and any contributions for the first year. Then, apply the interest rate to determine the year-end balance.
• Year Two and Beyond: For each subsequent year, add your annual contribution to the previous year’s balance, then apply the interest rate. Repeat this process until you reach your desired retirement age.

This approach will give you a rough estimate of the total value of the annuity when you retire.

Step 3: Estimate Your Lifetime Payout

To determine your annual income from the annuity, use the total value calculated at retirement and divide it based on the payout terms offered by the provider (e.g., fixed or increasing payments). Keep in mind that factors like your age, life expectancy, and optional features (e.g., inflation protection) can affect the final payout amount.

For a more precise estimate, consider working with a financial advisor who can account for additional variables like inflation and changes in interest rates.

Costs Associated with Lifetime Annuities

Anytime you’re considering what is lifetime income, there are likely taxes involved. There are other fees, as well. You’ll need to subtract these costs from any earnings you calculated in the previous step.

• Commissions. That person touting the benefits of a guaranteed lifetime annuity has some skin in the game. You’ll pay this person a cut of your principal when you purchase the policy.
• Management fees. These include underwriting costs and other fees associated with managing your policy and the money in it.
• Taxes. As with any income, the money you earn in your annuity will be taxed when you take it out. Assuming you’ve already paid taxes on the money you put into the fund, you’ll only pay taxes on the interest you earn.

Final Thoughts

A lifetime annuity incorporated into a well rounded retirement plan can be a valuable source of safe retirement income. If you’re thinking about an annuity, we recommend going through all of your options with a Certified Financial Planner®. If an annuity is a good option for you, an advisor can help you decide how much to put into the annuity based on your personal circumstances to get the results you want.

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Frequently Asked Questions

What makes a lifetime annuity different from other retirement income options?

An annuity is the only retirement investment product that offers a guaranteed income until you die. While pensions are similar, in that they also offer a specific income after you retire from work, they are employer-sponsored and not something you can choose to invest in. In addition, they are falling out of favor—especially in the private sector. Annuities allow you to make a lump-sum or series of payments in exchange for guaranteed income during retirement, until you die.

How can a lifetime annuity provide financial security in retirement?

Lifetime annuities can offer peace of mind to retirees, as they provide regular, stable, consistent payments during retirement until the retiree dies—this can reduce the stress around budgeting, as you know exactly how much you will get from your annuity each month. In addition, some annuities have provisions allowing you to distribute remaining investment funds to a beneficiary.

How does the payout structure of a lifetime annuity work?

There are many factors that determine the payout of an annuity. The main factor, of course, is how much you’re willing to purchase and how many additional payments you make into the annuity. Other considerations include your payout rate, your gender, and your age when you begin receiving income.

What are the tax implications of receiving lifetime annuity payments?

Annuities grow tax-deferred—you won’t pay taxes on your investment while it grows. Your distributions, however, will be taxed as ordinary income. If you are under 59 ½ and withdraw funds from the annuity, the taxable portion of the withdrawal is subject to a 10% tax penalty.