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Life Annuity

A life annuity guarantees lifetime income, reducing the risk of outliving savings. However, it lacks liquidity, may not leave money for heirs, and faces inflation risks. Ideal for retirees seeking financial security, but those valuing flexibility should explore alternative investments like bonds, stocks, or real estate.
Updated 28 May, 2025

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Should you buy a life annuity? Pros, cons, and risks

Retirement planning isn’t just about saving money—it’s about making sure that money lasts. One of the biggest fears retirees have is running out of funds too soon. A life annuity offers a solution by providing guaranteed income for as long as you live. It sounds like a great deal, but is it really?

While annuities ensure financial security, they also come with trade-offs. The biggest downside is that once you invest in a life annuity, you typically can’t get your money back. If you pass away earlier than expected, the remaining balance doesn’t go to your heirs unless you have specific provisions in your contract. That’s why some people see life annuities as a gamble.

This guide breaks down how life annuities work, the different types available, their advantages and risks, and whether they’re the right fit for your retirement strategy. If you’ve ever wondered whether you should trade a lump sum for a lifetime income, you’ll find the answers here.

What is a life annuity?

A life annuity is a contract between you and an insurance company where you pay a lump sum or series of contributions in exchange for regular payments that last as long as you live. In simple terms, it’s a way to turn your savings into a steady income stream. Once the payments start, you receive money at fixed intervals, whether it’s monthly, quarterly, or yearly.

Unlike other annuities that may pay out for a fixed period, a life annuity continues until you pass away. This makes it a popular choice for retirees who are concerned about outliving their savings. However, since payments are based on life expectancy, those who live longer benefit the most, while those who pass away earlier may not get back the full amount they invested.

One key reason people buy life annuities is the peace of mind they provide. Many retirees fear running out of money, especially if they don’t have a pension. A life annuity eliminates this worry by ensuring a guaranteed paycheck for life.

The concept behind life annuities is known as risk pooling. Insurance companies calculate payments based on the expected lifespan of annuitants. Those who pass away early help fund the payments of those who live longer. This system allows insurance companies to provide lifelong income, but it also means you may not leave money behind for your heirs.

For those who want a predictable, hands-off way to receive income in retirement, a life annuity can be a solid option. However, understanding how they work and what factors affect payouts is crucial before making a commitment.

How does a life annuity work?

The two main phases

A life annuity has two key phases: the accumulation phase and the annuitization phase.

The accumulation phase is when you fund the annuity. Some people purchase a life annuity with a single lump sum, such as money from a 401(k) or an inheritance. Others contribute to it over time, especially if they’re buying a deferred annuity that won’t start paying out until years later.

The annuitization phase is when you start receiving payments. This can begin immediately if you purchased an immediate annuity, or it can start years down the line if you bought a deferred annuity. Once the annuitization phase begins, you will receive regular payments for the rest of your life, no matter how long you live.

Payment structures and options

Life annuities come with different payout structures, which affect how much money you receive and how long payments continue.

A fixed annuity provides a consistent payment amount that never changes. This is ideal for retirees who want predictable income. A variable annuity, on the other hand, ties payouts to investment performance. If the market performs well, your payments may increase. If the market drops, your payments could shrink.

Another important distinction is between single-life and joint-life annuities. A single-life annuity covers only one person. Once the annuitant passes away, the payments stop. A joint-life annuity, however, continues making payments to a surviving spouse or beneficiary. This ensures that both partners have lifelong income, but the trade-off is that the initial payment amounts are usually lower than those of a single-life annuity.

Many annuities also offer period-certain options, which guarantee payments for a minimum number of years, even if the annuitant dies early. If someone buys a life annuity with a 20-year period certain and passes away after 10 years, the annuity will continue payments to their designated beneficiary for the remaining 10 years. A lifetime-only annuity, however, stops payments as soon as the annuitant dies.

How payments are determined

Several factors influence how much an annuitant receives each month.

Age plays a big role. The older you are when you start receiving payments, the higher your payout will be. Since insurance companies calculate payments based on life expectancy, someone who buys an annuity at 70 will receive larger monthly checks than someone who buys one at 60.

Gender also matters. Women generally receive lower monthly payments than men because they have longer life expectancies. Since annuity payments are designed to last a lifetime, longer life expectancy means lower monthly checks.

Interest rates at the time of purchase affect payouts as well. When interest rates are high, insurance companies can invest annuity funds more profitably, leading to higher payments for annuitants. When interest rates are low, payouts tend to be smaller.

The amount of money you put into the annuity is, of course, a key factor. The more you invest, the higher your payments will be. Some people use a portion of their retirement savings to fund an annuity, while others roll over an entire 401(k) or IRA.

Insurance companies use complex actuarial calculations to set payment amounts. They pool the risk among all annuitants, ensuring they have enough money to pay those who live longer while still making a profit.

The major types of life annuities

Immediate vs. deferred life annuities

Immediate annuities start paying out as soon as they are purchased, typically within 30 days. These are ideal for retirees who need income right away.

Deferred annuities, on the other hand, delay payments until a later date. Some people buy a deferred annuity in their 50s or 60s but don’t start collecting payments until they reach 70 or older. This allows the annuity to grow tax-deferred, potentially leading to larger payouts.

Fixed vs. variable life annuities

Fixed annuities offer guaranteed, unchanging payments. This makes them a safe choice for retirees who want predictable income without market risk.

Variable annuities invest in stocks and bonds, meaning payments can fluctuate based on market performance. While they offer the potential for growth, they also carry the risk of lower payments during market downturns.

Joint vs. single-life annuities

Single-life annuities provide income only for the annuitant. Once they pass away, payments stop. This type of annuity generally provides the highest monthly payouts.

Joint-life annuities continue payments to a surviving spouse or beneficiary. While this ensures lifelong income for both parties, the initial payments tend to be lower than those of a single-life annuity.

Choosing the right type of life annuity depends on your financial situation, risk tolerance, and whether you need to provide for a spouse after you’re gone.

The advantages of a life annuity

Lifetime income security

The biggest advantage of a life annuity is that it guarantees income for as long as you live. With longer life expectancies, many retirees worry about outliving their savings. A life annuity eliminates that risk.

Simplicity and ease of financial management

Unlike investment portfolios, which require careful planning and management, a life annuity provides a hands-off approach. Once you start receiving payments, you don’t have to worry about market fluctuations or making withdrawal decisions.

Potential tax advantages

Money inside a deferred annuity grows tax-free until you start withdrawals. When payments begin, only the portion representing interest earned is taxable. This can help retirees manage their tax burden more effectively.

Protection from longevity risk

A life annuity ensures financial stability even in old age. Whether you live to 80, 90, or beyond, your annuity keeps paying, providing peace of mind and security in retirement.

The disadvantages and risks of a life annuity

No access to principal

One of the biggest downsides of a life annuity is that once you purchase it, you typically can’t access the money you invested. Unlike a savings account or an investment portfolio, where you can withdraw funds as needed, a life annuity locks in your money in exchange for guaranteed payments. This lack of flexibility can be a problem if you need a large sum for an emergency, medical expenses, or other unexpected costs.

Since you’re trading a lump sum for ongoing payments, you no longer have control over your original investment. If you pass away early, you may not get back what you put in, unless you have a special rider that allows for beneficiary payouts. This is a major concern for retirees who want to leave an inheritance for their loved ones.

Inflation risk

A fixed life annuity provides the same payment amount for life, which may sound good at first. However, over time, inflation can eat away at the purchasing power of those payments. What seems like a comfortable income today may not be enough in 20 or 30 years.

Some annuities offer inflation protection, where payments increase over time, but these options typically cost more or come with lower initial payouts. If you choose a standard life annuity, you must plan for the fact that the real value of your payments will decrease as living costs rise.

Death before breakeven point

Life annuities are designed to provide income for as long as you live, but if you pass away soon after purchasing one, you may receive much less than what you originally paid in. This is especially true for single-life annuities that don’t offer a guaranteed minimum payout period.

For example, if you invest $200,000 into an annuity but pass away within five years, you may only receive a small portion of that money back through payments. Unless your annuity has a period-certain option, your beneficiaries won’t receive any remaining balance. This makes life annuities a risky bet for those with serious health conditions or a shorter life expectancy.

High fees and surrender charges

Life annuities often come with hidden costs. Some annuity providers charge high administrative fees, commissions, and surrender charges if you decide to cancel or cash out early. These fees can significantly reduce the value of your investment.

Additionally, if you purchase a variable annuity, you might face investment management fees, which further reduce your returns. It’s important to read the fine print and understand all costs before committing to an annuity contract.

Opportunity cost

By purchasing a life annuity, you are tying up your money in a fixed payment system. If interest rates rise or better investment opportunities come along, you won’t be able to take advantage of them. Some retirees prefer to invest in dividend stocks, real estate, or bond ladders, which can provide similar levels of income with greater flexibility.

If you have other sources of guaranteed income, such as Social Security or a pension, you may not need a life annuity. In some cases, you might be better off keeping your retirement savings in investments that offer both growth potential and liquidity.

Who should consider a life annuity?

Ideal candidates

A life annuity is a great option for retirees who want financial security and don’t want to worry about managing their investments. If you’re concerned about outliving your savings, an annuity can ensure that you have income for the rest of your life.

It’s especially useful for people who don’t have a pension. Since pensions are becoming less common, many retirees use annuities to create a steady income stream. If you prefer a hands-off approach to managing money in retirement, an annuity can provide peace of mind.

A life annuity is also a good choice for those who are in good health and expect to live a long time. Since the annuity payments continue for life, the longer you live, the more you get back. If you outlive your original investment, you will receive more than what you paid in.

Who should avoid it?

If you value flexibility and access to your money, a life annuity might not be the best choice. Once you annuitize, you lose access to your lump sum. If you need cash for medical bills, home repairs, or other big expenses, you won’t be able to withdraw from the annuity.

People with a shorter life expectancy may also want to reconsider. If you have a serious health condition, you might not live long enough to receive the full value of your annuity. In such cases, it may be better to keep your money in investments that can be passed on to your heirs.

If you’re comfortable managing investments or have other reliable income sources, such as rental properties or a pension, an annuity may not be necessary. Many retirees use a mix of income sources instead of putting all their money into one financial product.

Tips to choose the right life annuity

Assessing your financial needs

Before purchasing an annuity, evaluate how much guaranteed income you need. If you already have Social Security or a pension, you may only need a small annuity to supplement those sources. On the other hand, if you have no other fixed income, you might need a larger annuity to cover basic expenses.

Comparing annuity providers

Not all annuities are created equal. Different insurance companies offer different payout rates, fees, and contract terms. It’s important to compare multiple providers to find the best deal. Choosing a financially stable insurance company is crucial since your payments depend on their ability to stay in business for decades.

Understanding fees and contract terms

Many annuities come with hidden fees that reduce your overall return. Administrative costs, commissions, and surrender charges can eat into your investment. Always read the contract carefully and ask about any fees before signing.

Inflation protection options

Some annuities allow you to add an inflation rider, which increases your payments over time to keep up with rising costs. While this can be beneficial, it usually comes at the cost of lower initial payouts. Consider whether you need inflation protection based on your expected expenses.

Customization features

Life annuities can include optional riders that provide additional benefits. Some allow for a death benefit, which ensures that beneficiaries receive a portion of the annuity if you pass away early. Others include long-term care benefits, which provide extra payments if you need assisted living or nursing care.

Alternatives to life annuities

Dividend-paying stocks

Some retirees prefer to invest in dividend-paying stocks, which provide regular income while keeping their money accessible. Unlike annuities, these investments allow for capital growth and can be passed on to heirs.

Bonds and bond ladders

Bond ladders involve buying bonds with different maturity dates, ensuring a steady stream of income while preserving capital. This strategy can provide predictable returns with more flexibility than an annuity.

Real estate investments

Rental properties can generate monthly income, similar to an annuity, but offer the advantage of appreciating in value over time. However, real estate requires active management and comes with risks.

Withdrawal strategies from retirement accounts

Some retirees follow a safe withdrawal rate, such as the 4% rule, which allows them to withdraw a set percentage from their investments each year. This approach provides income while maintaining flexibility.

Common misconceptions about life annuities

“Annuities are only for the elderly”

Many people think annuities are only for those in their 70s or 80s, but younger retirees can also benefit. Deferred annuities allow people to buy in early and receive larger payouts later in life.

“Annuities are the same as pensions”

While both provide lifelong income, a pension is typically provided by an employer, whereas an annuity is purchased with personal savings.

“Life annuities are too expensive”

Some people assume annuities require a huge upfront investment, but there are options for different budgets. Many annuities allow for smaller contributions over time.

Final thoughts

A life annuity can be a smart way to ensure lifetime income, but it’s not the right fit for everyone. If you value financial security and don’t want to worry about outliving your savings, it could be a good choice. However, if flexibility and control over your money are important to you, there may be better alternatives.

Before making a decision, consider your financial situation, health, and other sources of income. Consulting a financial advisor can help you determine whether a life annuity aligns with your retirement goals.

FAQs

What happens to my life annuity if the insurance company goes bankrupt?

If the insurance company providing your life annuity goes bankrupt, your payments could be at risk. However, many countries have guaranty associations or schemes that protect policyholders up to a certain limit. It’s essential to research your country’s specific protections and consider the financial strength of the insurer before purchasing an annuity.

Can I convert my life insurance policy into a life annuity?

Yes, some life insurance policies offer a feature called an “annuity conversion” or “settlement option,” allowing you to convert the policy’s cash value into a life annuity. This can provide a steady income stream during retirement. Consult with your insurance provider to understand the terms and potential benefits of such a conversion.

Are life annuity payments affected by market fluctuations?

It depends on the type of annuity. Fixed life annuities provide consistent payments that are not influenced by market changes. In contrast, variable life annuities have payments that fluctuate based on the performance of underlying investments, making them susceptible to market volatility.

Is it possible to outlive the income from a life annuity?

No, one of the primary benefits of a life annuity is that it guarantees income for the rest of your life, regardless of how long you live. This feature provides financial security, ensuring you won’t outlive your retirement income.

Can I purchase a life annuity with funds from my retirement accounts?

Yes, you can use savings from retirement accounts like 401(k)s or IRAs to purchase a life annuity. This can be an effective way to convert your retirement savings into a predictable income stream. However, it’s important to consider potential tax implications and consult with a financial advisor to ensure this strategy aligns with your retirement goals.

Alisha

Content Writer at OneMoneyWay

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