For most of us, annuities are important for retirement income security, study finds

Annuities are a popular financial product that can provide a steady income stream during retirement. They are essentially contracts between an individual and an insurance company, where the individual pays a lump sum or makes a series of payments, and in return, the insurer agrees to make periodic payments to the individual, either immediately or at a future date. This is particularly important for retirees who want to ensure a stable income stream to cover their essential expenses, regardless of how the stock market performs.

Here's how an annuity works:

• Purchase. You buy an annuity contract from an insurance company, either with a single lump sum payment or a series of payments over time.
• Accumulation phase. If you have a deferred annuity, your money grows tax-deferred during the accumulation phase until you begin receiving payments.
• Payout phase. When you're ready to start receiving income, the annuity enters the payout phase. You can choose to receive payments for a specific period (such as 10 or 20 years) or for the rest of your life, depending on the type of annuity and the terms of your contract.
• Payment calculation. The amount of your annuity payments is based on factors such as the type of annuity, your age, your gender, the amount you contributed and the length of the payout period.
• Taxes. Annuity earnings are tax-deferred, meaning you don't pay taxes on the money your annuity earns until you start receiving payments. When you do start receiving payments, the portion of each payment that comes from your earnings is taxed as ordinary income.

When selecting an annuity for retirement, consider the following factors:

• Your retirement goals. Consider your retirement lifestyle and the amount of income you'll need to support it. Factor in other sources of income, such as Social Security, pensions and savings.
• Your risk tolerance. Fixed annuities offer the lowest risk but also the lowest potential returns. If you're comfortable with some market risk and want the potential for higher returns, a variable or indexed annuity might be a better fit.
• Fees and expenses. Annuities can come with various fees, such as mortality and expense fees, surrender charges and investment management fees. Make sure you understand all the costs associated with the annuity before investing.
• The insurer's financial strength. Since an annuity is a long-term investment, it's crucial to choose an insurance company with a strong financial rating and a solid track record of meeting its obligations.

There are several types of annuities, each with its own unique features and benefits:

• Fixed annuities. These annuities offer a guaranteed fixed interest rate for a specific period. The insurance company assumes the investment risk and promises a fixed payment amount, regardless of market fluctuations. Fixed annuities are generally considered low-risk and provide a stable, predictable income stream.
• Variable annuities. With variable annuities, your money is invested in a range of subaccounts, similar to mutual funds. The performance of these subaccounts determines the value of your annuity and the amount of your payments. While variable annuities offer the potential for higher returns, they also carry more risk, as payments can fluctuate based on market conditions.
• Indexed annuities. Indexed annuities combine features of fixed and variable annuities. They offer a guaranteed minimum return, but the actual return is tied to the performance of a specified market index, such as the S&P 500. If the index performs well, you can earn higher returns, but your returns are typically capped at a certain percentage.
• Immediate annuities. With an immediate annuity, you begin receiving payments shortly after making your initial investment. This type of annuity is often used by retirees who need an immediate income stream.
• Deferred annuities. Deferred annuities have an accumulation phase, during which your money grows tax-deferred. You begin receiving payments at a later date, often when you retire. Deferred annuities can be fixed, variable, or indexed.

Purchasing annuities can be wise decision for those seeking a reliable income stream in retirement, but it's essential to weigh the advantages and disadvantages before making a decision. Annuities offer several attractive benefits, such as guaranteed income, tax-deferred growth and customization options, which can make them a valuable addition to a retirement portfolio. However, they also come with some potential drawbacks, including complexity, lack of liquidity, opportunity costs and counterparty risk.

Let’s take a closer look at the pros and cons of investing in annuities to help you determine whether this financial product aligns with your retirement goals and risk tolerance:

• Guaranteed income. Annuities can provide a reliable income stream that lasts for a specified period or even for the rest of your life, helping to mitigate the risk of outliving your savings.
• Tax-deferred growth. Money in an annuity grows tax-deferred, meaning you won't pay taxes on the earnings until you start receiving payments. This can help your money grow faster.
• Customization options. Many annuities offer riders or optional features that can be customized to your specific needs, such as inflation protection, long-term care benefits, or death benefits for your beneficiaries.
• No contribution limits. Unlike 401(k)s and IRAs, there are no annual contribution limits for annuities, making them an attractive option for those who want to save more for retirement.
• Complexity. Annuities can be complex financial products, with various fees, riders and terms that can be difficult to understand. It's important to do your research and consult with a financial professional before investing.
• Lack of liquidity. Most annuities have surrender periods during which you'll pay penalties for withdrawing funds over a certain amount. This lack of liquidity can be a drawback if you need access to your money in an emergency.
• Opportunity cost. When you purchse an annuity, you're tying up your money for a long period. This means you may miss out on other investment opportunities that could potentially offer higher returns.
• Counterparty risk. The safety of your annuity depends on the financial strength of the insurance company. If the insurer goes bankrupt, you could lose some or all of your investment.

The Morningstar study highlights the critical role that annuities can play in providing a stable and guaranteed income stream for the majority of retirees. While annuities may not be the optimal choice for the wealthy, they offer a practical solution for most individuals seeking financial security in retirement.

The research emphasizes that few people have accumulated sufficient wealth to make annuity purchases unnecessary, challenging the common misconception that annuities are only beneficial for a select group. Instead, the study suggests that annuities, particularly fixed single premium immediate annuities (SPIAs) and deferred income annuities (DIAs), provide the most effective protection against outliving one's retirement savings.

By incorporating annuities into a comprehensive retirement plan, retirees can ensure a steady stream of income to cover their essential expenses, regardless of stock market performance. The study also highlights the importance of proper asset allocation when including annuities in a retirement portfolio, as well as the value of the Social Security bridging strategy to maximize lifetime payouts.

Ultimately, the findings of this study underscore the significance of annuities as a valuable tool for securing financial stability and peace of mind in retirement. As individuals navigate the complex landscape of retirement planning, it is crucial to consider the potential benefits of annuities and consult with trusted financial professionals to determine the best course of action for their unique circumstances. By doing so, retirees can take a significant step toward ensuring a comfortable and financially secure retirement.