Evaluating Different Annuities To Fit Your Financial Plan

Annuities can be a powerful financial tool — if they align with your broader financial plan. At Mercer Advisors, we help you understand the purpose and structure of different annuities. This way, you can make informed choices that support your goals. 

What is an annuity? 

An annuity is a contract between you and an insurance company designed to help protect and grow retirement assets. It can provide tax-deferred growth and, in many cases, guaranteed income for life. But like any insurance offering, depending on the type of annuity, they may include costs, conditions, and suitability considerations that you must weigh carefully. 

Immediate vs. deferred annuities 

One consideration between types of annuities is timing differences for income payouts: 

• Immediate annuities begin paying income within a year of purchase. Retirees often use them to convert a lump sum into predictable monthly income. 

• Deferred annuities allow your investment to grow tax-deferred, with income starting later. These are better suited for individuals still in their asset accumulation phase who want to lock in future income with tax-deferred retirement options. 

Qualified vs. non-qualified annuities 

Understanding the tax treatment of your annuity is essential, especially if you’re in a higher tax bracket. Taxation applies to how the annuity is funded: 

• Qualified annuities are purchased with pre-tax dollars like traditional IRAs or 401(k) accounts. Withdrawals are fully taxable. 

• Non-qualified annuities are funded with after-tax dollars like Roth IRA or 401(k) contributions. Only the earnings portion is taxed upon withdrawal. 

Riders and customization 

Many annuities offer optional riders. These are features you can add to an annuity contract to tailor it to your specific financial goals. Here are some common riders: 

• Guaranteed Lifetime Withdrawal Benefit (GLWB): Provides guaranteed lifetime income, even if the account value drops to zero. 

• Death benefit enhancements: Help ensure heirs receive a minimum payout, regardless of market performance. 

• Living benefits: Access to funds should you be deemed terminally ill. 

• Long-term care riders: Help cover gaps in traditional health insurance or Medicare by increasing or adding payments for long-term care costs.  

Liquidity considerations 

Annuities can be either short or long-term contracts and may impose surrender charges for early withdrawals. Before committing, it’s important to assess your liquidity needs, particularly for retirement income planning. 

Review the annuity surrender charges and “surrender schedule.” The schedule will outline the timeline of fees or penalties you’ll incur if you withdraw money from an annuity before a specified period ends. 

Check if you can make partial or penalty-free withdrawals. Also, check if there are 1035 exchanges allowed for moving funds between insurance contracts without causing a taxable event. A tax or insurance professional can help with understanding 1035 exchange rules. A 1035 exchange is a well-used mechanism to maximize interest rates when out of the surrender period. 

Fixed annuities 

Fixed annuities offer guaranteed interest rates and principal protection. They’re often compared to Certificates of Deposit and Bonds, but with tax-deferred growth. However, CDs are shorter-term and bank-issued, while annuities are typically longer-term and issued by insurance companies, often with additional features like lifetime income options. 

• Consistency: Fixed annuities offer consistent income payments, making them a stable retirement income option. This predictability can be beneficial if you want to reduce uncertainty, particularly in volatile market environments. At Mercer Advisors, we often position fixed annuities as a complement to more variable income sources like Social Security or investment portfolios. 

• Fees: Compared to variable annuities, indexed annuities and fixed annuities carry little to no fees. There are no costs for investment management or complicated rider fees. This means more of your money can earn income. 

• Limitations: While fixed annuities may provide stability, they can also cap your upside. The insurer sets the interest rate. If it lags behind market returns, it may make the annuity less effective for building wealth if you need more time or higher growth. Evaluating fixed annuities in the context of your full portfolio can help ensure they serve a specific purpose without compromising long-term growth. 

Since payments remain constant over time, the purchasing power of fixed annuities can decline as inflation rises ── unless an inflation protection rider has been selected. This erosion can have an impact on a 20- or 30-year retirement. We help clients assess whether inflation-adjusted alternatives or diversified income strategies may better preserve real value over time. 

Planning insight: Fixed annuities can be a good choice for conservative investors. They offer bond-like options, especially when interest rates are good.

Variable annuities 

Variable annuities allow you to invest in subaccounts similar to mutual funds. The returns and future income depend on market performance. 

• Risk: While investing can offer growth potential, it also introduces risk. If you are close to retirement or prefer less risk, the market ups and downs may not fit your income needs or comfort level. We help clients evaluate whether the potential upside of a variable annuity justifies the risk, especially when compared to other investment vehicles already in their portfolio. 

• Fees: Variable annuities often carry multiple layers of fees, which can significantly impact long-term returns. Combined, these fees typically range from 2% to 4% annually. Assess the cost and compare it to lower-fee alternatives like IRAs or brokerage accounts. 

• Optional products: Variable annuities offer optional riders for lifetime income or death benefits that can enhance the contract’s value. These features can offer reassurance, but they also add complexity and cost. 

Planning insight: Variable annuities may suit investors who’ve maxed out other tax-advantaged accounts and want growth potential with optional income guarantees. However, they require careful evaluation of fees and investment options including fixed vs. variable annuity.

Indexed annuities 

Indexed annuities offer returns linked to a market index, such as the S&P 500. They can also have downside protection, like a floor of 0%. This is different from variable annuities, which expose your investment to market risk. There may also be caps that limit your upside.  

This trade-off is important to understand. Indexed annuities are not designed to outperform the market — they’re meant to provide moderate growth with downside protection. 

• Protection: The floor can help ensure you won’t lose money due to market downturn. This protection is attractive if you are close to retirement. It allows you to enjoy market growth without risking your main investment. 

• Limitations: Returns are typically subject to caps, spreads, or participation rates, which limit how much of the market’s upside you receive in a given period. For example, if the S&P 500 gained 10% in a year and your annuity had a 5% cap, your credited return would be limited to 5%. A participation rate could be 80% of index gains. 

• Interest credit: Indexed annuities use intricate formulas to determine how interest is credited — they can be difficult to interpret and vary widely between solutions and insurers. These formulas could include point-to-point indexing (comparing index values at two dates), monthly averaging, participation rates, and caps and floors. 

Planning insight: Indexed annuities may appeal to investors who want modest equity exposure without risking principal. They’re often used as part of a diversified retirement income strategy.

Registered Index-Linked Annuities (RILAs) 

RILAs are a hybrid between indexed and variable annuities. They offer partial downside protection (via buffers or floors) and more upside potential than traditional indexed annuities. 

Planning insight: RILAs might be a good consideration for moderately risk-tolerant investors who want defined outcome ranges.

When does an annuity make sense? 

Annuities are not ideal for everyone, particularly when needing short-term access to funds (less than two to three years) or flexible investment options. It’s important to keep in mind that annuities are relatively illiquid, if not structured properly to meet your overall needs. 

They may be suitable in some cases. For example, if you have maxed out other retirement accounts, if you want guaranteed income to help with Social Security, or if you’re looking for options to gift to your favorite charity.

A planning approach 

Mercer Advisors is a fiduciary, which means we don’t sell products that are not in your best interest. We build financial plans. Therefore, our approach includes: 

• Reviewing your full financial picture before recommending an annuity 

• Evaluating liquidity, tax implications, and income needs 

• Advising on whether an annuity fits within your broader retirement strategy 

• Examining existing annuities to determine whether they still serve your goals 

An annuity can be a valuable part of a retirement plan, but should be chosen thoughtfully with an evaluation of annuity pros and cons. Whether you’re considering a new annuity or reviewing an existing one, Mercer Advisors is here to help you navigate the options with clarity and confidence. 

If you’d like to explore whether an annuity fits within your financial plan, reach out to your advisor or schedule a review. We’ll walk through your goals, liquidity needs, and income strategy to ensure every decision supports your path to Economic Freedom™. 

Not a Mercer Advisors client and want to know more about whether annuities are right for you? Let’s talk.