#115 - Understanding Annuities Before You Decide if They Belong in Your Retirement Plan

Eric Blake: I want to help you understand what annuities are, why they exist, and how to ask better questions before making what could be one of the largest financial decisions of your retirement.

Eric Blake: Welcome to another episode of the Simply Retirement Podcast. I am your host, Eric Blake. Joining me once again is Wendy McConnell. Wendy, how are you?

Wendy McConnell: I'm good. How are you?

Eric Blake: I'm very good. So today we are starting a four-part series on annuities, one of these very fun topics. But I'm actually, I just want to pull back the curtain a little bit, though, if that's okay with you.

Wendy McConnell: Sure.

Eric Blake: So I am a self-proclaimed retirement planning nerd. Would you agree? You've agreed with that many times. I don't think this is any surprise to you, right?

Wendy McConnell: I don't think anybody would disagree with that statement.

Eric Blake: But actually, that's a good thing when you're talking about breaking down a financial plan, a retirement plan, doing tax projections, all those fun things that I love to do that you don't like so much. But it's not so good for when you're doing a podcast, to sound like a nerd, right?

Wendy McConnell: Well...

Eric Blake: So...

Wendy McConnell: Yeah...

Eric Blake: So, so you're going to go along with this, I understand. So this is the second attempt we've made at this topic, because I decided, after getting a little bit of feedback from you, as my amazing producer, that the last time wasn't all that clear, a little confusing. And that's what sometimes happens. I'll catch myself getting too deep into nerd mode, or I make it sound like I'm talking to other nerds, which I'm not.

But I think one of the things that, just to be completely clear, one of the great things about having you on my show is that you fall squarely in the target demographic that I'm trying to connect with. And it is funny, you tell me what you think, though, that age 55 is just kind of like a magic number.

Even before, even 54 is not the same. Once you hit 55, you're kind of in that retirement red zone. There are big decisions to be made. You're making some of these yourself. We don't necessarily have to get into those, but...

Wendy McConnell: Right...

Eric Blake: But there's a lot of things that happen once you reach 55. As you're approaching retirement, there are critical decisions to be made, and I think one of the things that I so appreciate about you is the feedback that I get, even what's verbal and non-verbal.

Wendy McConnell: Onscreen and offscreen.

Eric Blake: Whether this topic, or whether the conversation, is sinking in.

Wendy McConnell: Yeah. Well, you know, kudos to you. You didn't have to bring this up at all. It really wasn't necessary. But yeah, at the end of the last one, I was just like, "Huh."

Eric Blake: Well, and I think one of the things that helps me is, you know, there's a lot of conversations on all the... There's a lot of podcasts on all these topics. A lot of retirement planning podcasts go deep into different topics, and my focus, because of my background and where my passion is, is working with women who have gone through a divorce, or been widowed, or, none of those have to be true.

It's just, "Hey, I'm ready to take control. I want to make good decisions about my retirement. I want to be part of that conversation." And that's really what I try to accomplish with the podcast, is bringing topics that give you... Again, what I talk about a lot is just helping you ask, I'm not asking you to be an expert.

What I would like to do is help you ask the right questions.

Wendy McConnell: Mm-hmm.

Eric Blake: That's why annuities, having this conversation about annuities, I think is so important. So what I decided to do after our first attempt is break this down into several segments, and the reason for that is, number one, I want to make sure there's a clear understanding of what an annuity is.

That's first.

Wendy McConnell: All right.

Eric Blake: Then we'll get into what are the different types of annuities, and that's where a lot of this confusion comes in, because most people just hear the word annuity and they think one thing, or maybe they think something else. But there are a lot of different types of annuities, and we're going to break those down.

We're going to talk about the taxation. And again, once we get to the fourth episode, I'm going to do a four-episode series here, is what questions should I ask? What do I need to know? If I'm really thinking about an annuity, what should I really know, or what should I be asking, in order to make an educated decision?

But today we're starting with what actually is an annuity.

Wendy McConnell: Well, and I think a lot of people are familiar with the term annuity when it comes from the lottery. Isn't that an annuity, that you have the option...

Eric Blake: Yeah, so you get the option, okay, do I want the lump sum or do I want the annuity, right?

Wendy McConnell: Right, which is an every-year payment, right?

Eric Blake: It is. When...

Wendy McConnell: ...it comes to the lottery, right.

Eric Blake: Okay. And that's what most people think about. When you think about the word annuity, it's, "Hey, there's a lump sum of money sitting out there somewhere." If it's a lottery, it's somebody giving you a lump sum, or you deciding, "I want the annuity payout."

But a lot of people, when it comes to retirement planning, well, the definition of a annuity is that it's actually an insurance contract. They're issued by insurance companies, for the most part, right?

Wendy McConnell: Okay.

Eric Blake: I put money in, and in return I get a stream of income. That could be monthly, it could be annually, it could be quarterly, whatever that might be.

But that's the basics of what an annuity is, okay? And it's probably once a week, every couple of weeks at least, I'll get, whether it might be a client, it might be a listener, one of our newsletter subscribers, they're going to email me and I'll get this question, "What do you think about annuities?"

Wendy McConnell: Okay.

Eric Blake: And that's why I wanted to do this series. That's a big part of it. Because over the years, what I've noticed is there's a very similar pattern, especially when we're talking about women who are making decisions on their own at this point, as they're approaching retirement, is, "Well, I've lost a spouse.

I've just gone through a divorce. I've retired after a long career. Maybe I received a life insurance benefit. I've inherited an IRA," whatever it might be. You simply reach the point where you're responsible for these big decisions, and before long, someone's going to ask, "Have you thought about an annuity?"

Wendy McConnell: Mm-hmm.

Eric Blake: It might be an insurance professional, an insurance agent. It might be your local State Farm agent or Allstate agent, or whoever might actually be approaching you with this idea. It might be a financial planner. And the problem isn't that annuities become part of the conversation, the problem is that those conversations often happen during some of life's biggest transitions, right?

Just like I said, whether it's losing a spouse, retirement, even... Retirement's obviously a big one, in which case maybe you've got a 401(k) that you've never had full control over, and you're trying to figure out, "Well, what do I do with this thing?" You might be grieving. You're adjusting to retirement.

There are emotions tied to all of this. Or you're simply saying, "How do I turn this nest egg that I've built up over these years, or received as an inheritance, or received as a life insurance payment, how do I turn that into an income?"

Wendy McConnell: Okay.

Eric Blake: Right? And that's one of the things I think is so important, is just to understand, if an annuity has been brought up, how do I know whether this is something I should even think about?

Wendy McConnell: Okay, so can we talk about the benefit of it, then? Wouldn't that be the first thing? I know what you're saying, what you're saying is, it's insurance, you know. It's insurance.

Eric Blake: Right.

Wendy McConnell: But insurance on what?

Eric Blake: So when you think about the structure of an annuity, again, it's an insurance contract. I give the insurance company money, a lump sum, or it could be contributions. You could actually contribute to it over a time period, on a monthly basis, on an annual basis. I'm putting money into this annuity contract, and in return, at some point, that annuity is going to pay me an income.

Wendy McConnell: Okay.

Eric Blake: Okay? It could be immediate. It could be 30, 40 years from now, but that's the basic structure of an annuity. I put money in. At some point, I'm going to receive an income.

Wendy McConnell: All right, so they're going to give us a monthly income, or a yearly income, or however we set it up, I guess, right?

Eric Blake: That's the nature of the contract. So the contract says at some point you're going to have to start receiving income.

Wendy McConnell: Okay. Right? Well, yeah. Do people argue over that?

Eric Blake: Well, that's where some of the confusion comes in...

Wendy McConnell: Okay...

Eric Blake: ...because it's not the annuity itself. The problem is making the decision, I think, without fully understanding how a particular annuity works, right? The trade-offs involved, whether it's actually going to resolve a retirement challenge that you're facing, right? So that's what I really try to do. Throughout the series, I'm not trying to convince anybody to buy an annuity...

Wendy McConnell: Mm-hmm...

Eric Blake: ...or to avoid an annuity, right? It's not good or bad, it just is what it is.

But I want to help you understand what annuities are, why they exist, and how to ask better questions before making what could be one of the largest financial decisions of your retirement, right? The other thing I'm going to do is include a free companion guide along with this episode, and I'm going to make sure it's available throughout the series we're doing on annuities.

Does an annuity fit within my financial plan? And one of the reasons I like this guide so much is because it doesn't begin by asking which annuity you should buy. It begins with planning. What are you trying to accomplish? Do you actually need guaranteed income? How important is flexibility?

What are the trade-offs that you're willing to make? And these are the exact questions we're going to be asking throughout this series, again, because retirement planning should always begin with the planning objective before we start talking about a product. Any particular product, we need to think about what our goals are, what we're trying to accomplish, before we ever get to an annuity or any type of investment product like that.

Wendy McConnell: All right.

Eric Blake: All right. And so today we're going to begin with the most basic question of all, and that is, what is an annuity, right? We've already touched on that, but I just want to make sure it's clear.

Wendy McConnell: Mm-hmm.

Eric Blake: Explain why annuities exist, first of all, and build a foundation that will make the rest of this series much easier to understand.

Wendy McConnell: Okay.

Eric Blake: So I also wanted to point out that for all the links and resources, including that guide I just talked about, or to ask a question or suggest another topic, you can always visit thesimplyretirementpodcast.com. All right, so let's start again. Simple definition. I touched on it already, but an annuity is a contract between you and an insurance company.

Okay? You give the insurance company money, and in return, that company agrees, under the terms of the contract, to provide an income either immediately or at some point in the future. That's the foundation of every single annuity that's out there.

Wendy McConnell: Okay. Can I ask a clarifying question right away?

Eric Blake: Please.

Wendy McConnell: When you say it's for an income, specifically an income, that sounds like it's different than just payments. Is there a difference between income and payments?

Eric Blake: It depends on the terms of the contract. So you can actually receive dollars from your annuity contract without annuitizing. This really gets into the nuts and bolts, and I don't want to go too deep, but when you think about an annuity, there are basically two phases. Okay? So when I put money into the contract, again, it's either going to start paying me an income, or a payment, immediately...

Wendy McConnell: Mm-hmm.

Eric Blake: ...or it's going to start income or payments at some point in the future.

Wendy McConnell: Right.

Eric Blake: Five years from now, 10 years from now, 30 years from now, right? The annuity has two different phases. There's what's called the accumulation phase, and then there's the income phase, or you might refer to it as the payout phase, right?

Wendy McConnell: Okay.

Eric Blake: So if I decide, okay, I'm going to put money into this annuity, but I don't really need the income, maybe I'm 55, but I'm not going to retire until I'm 65, right? So I don't need the income for 10 years. Well, if I put the money into the annuity contract, what happens? I'm technically in what's called the accumulation phase.

Wendy McConnell: Mm-hmm.

Eric Blake: And we're going to get much more into this when we get into the types of annuities and what that actually means. But that's the point where I put my money in, and that money is basically sitting there until I get ready to use it. Now, it could be earning interest. It could be invested in the stock market, through what are called subaccounts.

There are many different possible options for how you can have that money sitting inside of that annuity contract, but that's the accumulation phase.

Wendy McConnell: Okay.

Eric Blake: Hey, everyone. It's Eric. Hope you're enjoying today's episode. I want to take just a quick moment to share a resource I think you'll find valuable.

Have you ever found yourself asking, how much can I put into an IRA this year? Or, how much can I earn before my Social Security gets reduced? Those are the kinds of questions that come up all the time, and the answers change more often than you'd think. That's why we created a free two-page tax and retirement planning cheat sheet, updated for 2026, with the key tax, Social Security, and retirement numbers all in one place.

You can download it right now at thesimplyretirementpodcast.com/retirementcheatsheet.

Wendy McConnell: It's a simple reference you can keep handy whenever questions come up. Now, back to the episode.

Eric Blake: The second phase is the income phase, and that's where you actually flip that switch and the contract begins providing income or payments.

Okay? We can refer to either one, so they're kind of interchangeable there. Some people move into that phase soon after purchasing that annuity, and others may wait for several years.

Wendy McConnell: Okay.

Eric Blake: And some people, I think this is where you were going with one of your questions, may never leave the accumulation phase, because they may choose the other options available to them under the contract instead of actually turning it into an income.

So if I put $100,000 into an annuity, but I never actually annuitize it or transition to that income phase, I can still take money out of that annuity contract without it being systematic, regular payments. Okay? So I put $100,000 in. Five years from now I can say, "Hey, an emergency has come up, I need to take $20,000 out."

Okay, I didn't annuitize it. My $80,000, plus whatever it's earned, is still sitting in that annuity contract, but I could have taken some money out of it for whatever reason.

Wendy McConnell: All right.

Eric Blake: Okay? Now, this is assuming there aren't different penalties, and that's where the complexity comes in. Most annuities will have some different surrender penalties, surrender charges, that are basically an incentive to leave that money in long term. Okay? And we're going to talk about all the taxation as we go through this series. We'll get to all these different pieces, but the first thing is, you've got these two phases.

We've got the accumulation phase, where the money is accumulating interest, earnings, or gains, and then we turn it into, eventually, the income phase. Every annuity contract has that income phase built in, which says, if I never actually need the money, for whatever reason, there's an age or a date out there that says you're going to have to turn this into income whether you want to or not.

Okay? Now, it might be 95, it might be 105. Again, it depends on the contract.

Wendy McConnell: All right.

Eric Blake: But that's where we try to distinguish between the accumulation phase and the income phase, right? So not every annuity is, "Hey, I gave you money, and immediately I start receiving income." Okay? That would be what's called an immediate annuity.

And again, we'll get more into that when we get to the types. But that's basically what an immediate annuity is, I put money in, and a month from now I start getting payments.

Wendy McConnell: Okay.

Eric Blake: But that's not every annuity. Again, that's where the complexity comes in. So if I put $100,000 in and say, "I don't really need income for another 10, 15, or 20 years," that money is sitting in the accumulation phase.

It might be earning a fixed interest rate, a variable interest rate, or any number of potential earnings features that could be included with your particular contract.

Wendy McConnell: That you would choose, I assume, or...

Eric Blake: Right...

Wendy McConnell: ...you know, okay.

Eric Blake: And again, we're going to talk about types next time, so hopefully this is building, one episode building on the other.

Wendy McConnell: Yeah.

Eric Blake: And so let's talk about why somebody would choose an annuity in the first place, okay? So if we understand that an annuity is an insurance contract where I put money in and at some point I'm going to start receiving an income, why would somebody choose one? Because if you don't understand the problem that an annuity is designed to solve, it's difficult to know whether or not it belongs in your retirement plan, right?

So think about your working years for just a minute. For decades, you've received money. It came in a paycheck on a regular schedule, every two weeks, once a week, twice a month, whatever it might be. However you were paid, you generally knew when that next paycheck was coming, right?

Wendy McConnell: Mm-hmm.

Eric Blake: And then one day that paycheck stops. Right? Now it becomes your responsibility to create your own paycheck when you get to retirement. That's the...

Wendy McConnell: Scary part. That's the scary part.

Eric Blake: And why annuities can sometimes be a really good solution, as long as you understand what the annuity is trying to accomplish, right?

Wendy McConnell: Mm-hmm.

Eric Blake: And for many retirees, the question isn't simply, "Have I saved enough?" The question becomes, "How do I turn what I've saved into a dependable income?" And that's one of the primary reasons that annuities exist.

Wendy McConnell: Okay.

Eric Blake: Okay. They're designed to help convert a portion of your retirement savings into an income.

Now, notice what I didn't say there. I didn't say it's the only way to create an income, because it's not the only option out there. Obviously, Social Security is one source of guaranteed income.

Wendy McConnell: Right.

Eric Blake: Some people still have pensions.

Wendy McConnell: Mm-hmm.

Eric Blake: Others may have rental income or some other dependable cash flow. An annuity is simply another tool that may help fill an income gap, if one exists.

Wendy McConnell: All right, tell me if I'm wrong, but I'm thinking that it's like guaranteed income.

Eric Blake: It's guaranteed to the extent of the insurance company itself, right? So just like anything, it's guaranteed as long as that company stays in business.

Wendy McConnell: Well...

Eric Blake: So conceptually, yes, it's guaranteed...

Wendy McConnell: Right...

Eric Blake: ...as long as, based on either your life expectancy, or joint life expectancy if you're married. It could be what's called a period certain, meaning a 10-year or 20-year guaranteed period. In general, you're absolutely right.

Wendy McConnell: But what I'm thinking is, comparatively to a 401(k), where you could lose a lot of it if there's a bad day or a couple of bad months on the stock market, that doesn't really affect an annuity.

Just that you can't make more.

Eric Blake: Yeah.

Wendy McConnell: Can you, like I know that if you're getting an interest rate, that's kind of like a bank. You're not going to lose your...

Eric Blake: The principal? Yes.

Wendy McConnell: Thank you.

Eric Blake: Right. Well, and that's where it gets into the types. Again, we've got to expand our thought process around what an annuity is.

Conceptually, they're all basically the same. Again, it's an insurance contract that I've put money into, and at some point I'm going to receive an income. But the way you structure that contract is going to be based on what your goals are, what your risk tolerance is, and things of that nature, right?

And so that's where we get into the types of annuity contracts, and that's where we're going to go much deeper on our next episode, right?

Wendy McConnell: All right.

Eric Blake: And so, again, the biggest question always comes back to this: what are you trying to accomplish? And although every retirement story is different, the planning question is often exactly the same.

Again, for women, they may have lost a spouse, may be adjusting to life after divorce, may be retiring after a long career. All these different situations where you've now got to figure out how you're going to generate income that you can't outlive. Or another way to say that is, how do you create a dependable income from the assets you have available?

Whatever the source of those assets, that's what I'm thinking about, and that's where an annuity may become part of that conversation.

Wendy McConnell: Okay.

Eric Blake: Again, not because it's automatically the right answer, but because it's simply one possible solution to this particular challenge, okay? Now, another feature of annuities to be aware of is something called tax deferral.

Wendy McConnell: Mm-hmm.

Eric Blake: Okay? So again, if we're in that initial accumulation phase, where I've just put the money in and I want it to earn something, whether I'm very conservative and getting a fixed rate, or maybe more aggressive, looking for variable or stock market-type returns, the interest I'm earning is tax-deferred, meaning I don't pay tax on that money until it actually comes out.

Now, we're actually going to devote an entire episode to the tax implications later in the series, because the rules can be very different depending on how that annuity is owned. Again, today, just remember this: an annuity is not a tax strategy. We're thinking about it primarily as an investment strategy or an income strategy, and everything else builds from that foundation, okay?

Wendy McConnell: Okay.

Eric Blake: So before someone starts explaining all the guarantees, all the interest rates, all the product features, again, I always come back to this simple question: what retirement challenge is the annuity intended to solve? If that question can't be answered clearly, it's probably too early to be talking about specific products anyway.

Wendy McConnell: Okay.

Eric Blake: As we think about annuities, before we finish today's episode, I want to leave you with a few thoughts, right? Hopefully you don't think about an annuity as simply another financial product. Instead, think about it as one possible tool within your retirement plan. The goal isn't simply to own an annuity.

The goal is to build a retirement plan that supports the life you want to live, okay? Sometimes an annuity may accomplish that. Sometimes some other strategy might be a better fit. But again, come back to that same question: what are we trying to accomplish? Why would we think about an annuity? Do I need the guaranteed income?

Do I need tax deferral? What am I trying to accomplish before we actually start thinking about how an annuity's going to fit in?

Wendy McConnell: All right.

Eric Blake: And again, next time we're going to start again. We're going to get into the types of annuities, because we've kind of touched on it as we've gone through this episode, about thinking about, well, what are the guarantees that annuities actually provide, right?

Whether it's a guaranteed interest rate, which is not all annuities, again, where some of that confusion comes in, because you can invest in variable accounts that go up and down, just like your 401(k) or any other type of investment. Investing in stocks, it goes up and down. You can do the same thing inside of an annuity, under the annuity umbrella.

Wendy McConnell: Well, I'm not going to ask this week, but I'm going to ask next week. Why? Why would we do that? Why would we put it in an annuity when we already have it in our 401(k)?

Eric Blake: And that's, again, where we start thinking about the benefits and features that annuities offer, with those different guarantees.

So I think, again, if you take one thing from today's episode, make it this: an annuity isn't the goal itself. Retirement planning is the goal. An annuity is simply one possible tool. Whether it's the right tool depends on what you're trying to accomplish. That's the question we'll keep asking throughout the series, and what retirement challenge are you trying to solve?

Wendy McConnell: Okay.

Eric Blake: Once you can answer that question, it becomes much easier to decide whether an annuity belongs in your retirement plan or not.

Wendy McConnell: Mm-hmm.

Eric Blake: And if it does, which type of annuity may be worth considering. And again, today was just more of a focus on the foundation.

In the next episode, we're going to build on that, and we'll start talking about the major types of annuities, and the retirement planning challenge that each of those different types of annuities is designed to solve.

Wendy McConnell: Gotcha.

Eric Blake: That make sense?

Wendy McConnell: Yep.

Eric Blake: So here are the three things I want you to take from today's episode: an annuity is a contract with an insurance company that's designed to provide an income, either immediately or at some point in the future.

Before evaluating an annuity, first understand the retirement planning problem you're trying to solve. Planning should always come before the products, okay? Today's episode laid the foundation. Then in the next episode, we'll explore the major types and why each one exists. And I think that's going to start clearing this up as we progress through the episode series, again, to make sure we understand how an annuity works, and how it might fit into your particular retirement plan.

Wendy McConnell: All right.

Eric Blake: Fair enough?

Wendy McConnell: Fair enough.

Eric Blake: So that's it for today's episode. As always, thank you for tuning in. Thank you, Wendy, for being here with me once again.

Wendy McConnell: Of course.

Eric Blake: For all the links and resources mentioned today, including your free copy of Does an Annuity Fit Within My Financial Plan, you can visit thesimplyretirementpodcast.com.

Again, next time we'll continue the series by taking a closer look at the major types of annuities, how they work, and, more importantly, what retirement planning challenge each of these types is designed to solve. Be sure to follow our show so you don't miss future episodes. And until next time, please remember, retirement is not the end of the road. It's the start of a new journey.