A path to lifelong income

Retirement isn't the end of the road; it’s the start of a whole new chapter of life. And with Americans living into their late 70s and 80s and beyond, that chapter can be surprisingly long.

If you retire at 67, you might have 15, 20 or even 30 years or more to enjoy. That’s why it’s so important to have a plan—not just to reach retirement but to help your money last as long as you do.

Enter annuities, which can provide you with regular payments for a specific number of years or for life. “They’re almost like a pension plan that you fund for yourself,” says Al Todd, Thrivent financial advisor with Todd Financial Associates in Allison Park, Pennsylvania.

Let’s answer some basic questions about these popular retirement products, so you can better decide whether they’re right for you.

A: An annuity is a contract between you and an insurance company that can help you reach specific goals, like growing your retirement savings, locking in guaranteed income or both.

You can fund an annuity through a lump-sum payment or a series of payments. Based on the type of annuity that you purchase, the money you contribute can grow at a fixed rate or have the potential to grow at a variable rate, depending on how the market performs. At a later point, you can elect to receive guaranteed annuity payouts, either for a specific number of years or for the rest of your life.

A: Your payout options depend on the type of annuity you choose. With an immediate annuity, the insurance company begins making regular payouts to you once you make your initial lump-sum premium payment. With a deferred annuity, however, those payouts don’t start until a future date. Generally, the longer you defer payouts, the higher your future guaranteed income stream will be.

A: Annuities come in several forms, each with its own rules for how your money grows and how payouts are handled. Understanding the differences can help you decide which annuity, or mix of annuities, best meets your needs.

Fixed annuities
Fixed annuities provide a guaranteed minimum interest rate on your contributions, so your money is shielded from the ups and downs of the market and offers a predictable return.

While it’s the type of annuity that carries the least risk, the returns are typically the most modest.

“A fixed annuity has guaranteed interest you can count on regardless of market conditions,” says Peter Go, a Thrivent financial advisor with the COR Financial Group in West Bend, Wisconsin. “They’re meant for somebody who tends to be more conservative with their money.”

A multi-year guarantee annuity, or MYGA, is a version of a fixed annuity that provides a fixed rate of return for a specific period, usually three to 10 years. Since you are selecting a specified time frame, there is typically a higher interest rate than other fixed-rate products.

Variable annuities
If fixed annuity products are all about predictability, variable annuities tend to attract savers hoping for greater growth and willing to take on more risk. Your rate of return is tied to the performance of the variable investment options you select, which have the potential for greater returns than a fixed annuity.

With the potential for greater growth in variable annuities comes greater risk, including the possibility of losing money.

Some insurers offer variable annuities with an optional Guaranteed Lifetime Withdrawal Benefit (GLWB) rider, for an additional fee. GLWB riders let you keep your money in the variable investment options while providing an insurance feature that guarantees specified guaranteed withdrawals for life, even if your annuity value is completely depleted.

Fixed index annuity
A fixed index annuity offers interest tied to the performance of a broad market index, such as the S&P 500, which gives you the potential for greater growth up to a cap if the index performs well.

Your premium is not invested in the market and will not decline due to market downturns. In exchange for that protection, fixed index annuities limit your potential gains. They may cap your returns or apply a participation rate that determines how much interest is applied to your annuity.

“A fixed index annuity is a good fit for someone who’s comfortable earning no interest in down years, in exchange for the potential to earn higher returns—up to a cap—when the index does well,” says Go.

A: It’s possible to lose money in some annuity contracts. However, the amount of risk you assume depends on the type you purchase:

• Most annuities come with a surrender charge period. That means if you take out more than the allowed amount during those years, you’ll pay a fee on the extra—sometimes as high as 9%. So, annuities are really meant to be long-term commitments, not short‑term solutions.
• In addition, if you select a variable annuity, you assume a greater degree of risk but with the potential for greater reward. Because your money is in variable investment options, you can lose value.

A: With fixed annuities, in addition to possible surrender charges, there may be annual contract fees. These are generally assessed only when contracts fall below a minimum value, says Go, so it’s considered rare.

Variable annuities tend to be pricier. You’ll typically pay an annual mortality and expense (M&E) fee to cover insurance risks and guarantees, plus investment management and other portfolio charges. You’ll pay extra for any riders you add. Altogether, costs can range from 1% annually for a basic contract to 4% for one with more guarantees, Go says.

Overall, annuities are usually more expensive than some other investments, says Todd, because you’re getting insurance protections you wouldn’t otherwise have. “It all comes down to how well you want to sleep at night,” he says.

A: The money you invest in an annuity grows tax-deferred, meaning you won’t owe taxes on interest, dividends or investment gains until you start taking withdrawals. How much you’re eventually taxed depends on whether you have a qualified or nonqualified annuity.

• A qualified annuity is funded with pre-tax dollars, usually through funds rolled over from an employer-sponsored retirement plan like a 401(k) or 403(b), or from a traditional IRA. Since you likely received a tax deduction on contributions, the entire withdrawal is taxed as ordinary income.
• You fund a nonqualified annuity with after-tax money (like personal savings or investments), so only the earnings are taxable, and those earnings are taxed at ordinary income rates.

A: Like any financial product, annuities come with both upsides and downsides. Here’s a quick look at the main ones to consider.

Pros:

• Guaranteed income: Some annuities provide guaranteed interest. Other annuities may have riders guaranteeing withdrawals for life. All deferred annuities provide settlement options where you can elect guaranteed annuity payouts for a specified timeframe or for the rest of your life. This key feature of annuities can help protect you from outliving your money.
• Tax-deferred growth: Money inside an annuity grows tax-deferred until you withdraw it.
• Principal protection: Fixed annuities are not subject to losses caused by market fluctuations.
• Death benefit guarantees: If you die before receiving the full amount you paid into the contract, most annuities will pay the difference to your beneficiaries, minus any withdrawals or fees.

Cons:

• Limited liquidity: During the first few years of your annuity, you only can withdraw a portion of its value before having to pay a surrender charge. That fee—generally starting at 3% to 10% before tapering off—can take a big chunk out of your balance.
• Inflation risk: During periods when the cost of living rises substantially, the return on some annuities may not keep up with the rate of inflation. Fixed index and variable annuities tied to the performance of the stock market may help you limit this risk.
• Market risk: With a variable annuity, you can lose money investing in the contract, including loss of principal.

A: Like most financial products, annuities aren’t the perfect solution for everyone. Here are some of the situations that could make you a good candidate for an annuity:

• You’re looking for a reliable income in retirement.
• You’re worried about outliving your savings.
• You’ve maxed out other tax-advantaged accounts such as 401(k)s and want another way to grow your money tax-deferred.
• You’re risk averse and want to protect your principal while still having the potential for growth.

Todd recommends looking at your unique situation—like your retirement goals, the other assets you own and how much income you get from Social Security—before deciding whether an annuity is the right answer for you.

“This is where working with a Thrivent financial advisor can be helpful,” he says.

Daniel Kurt is a writer in Virginia.

Client story: How MYGAs changed one couple's income

Ray Lalli could live with stock market volatility while he was working and putting 20% of his income into a 401(k). But when he retired from his managerial job in 2021, those ups and downs became harder to stomach.

Soon after he left the workforce, the S&P 500 lost about 25% of its value, causing Lalli, 67, to nervously watch what was happening to his hard-earned savings. “My favorite days were Saturday and Sunday, when the markets were closed,” he jokes, which meant he couldn’t lose any money those days.

Thrivent Financial Consultant Andrew Mortenson, with the COR Financial Group, suggested that Lalli and his wife Lorraine Lalli, a 65-year-old former executive administrator, purchase three multi-year guaranteed annuities (MYGAs) that offer fixed returns for a specific window of time. The Plymouth, Michigan, couple locked in rates as high as 5.7% while keeping the flexibility to withdraw up to 10% of their contract value annually.

Now, the Lallis use annuity distributions to cover taxes on their primary home and a second residence in South Carolina. Most importantly, they know their assets are protected no matter what’s happening on Wall Street.

“It gives us plenty of steady income, along with a pension and Social Security,” says Lalli. “Now we have no worries.”