#116 - Which Type of Annuity Fits Your Retirement Plan?

Eric Blake: If I'm just thinking about a financial concept, it's like going to a restaurant. The only thing I have to choose is what I want to eat, or maybe I'm going to eat inside or outside. But that's it, the food just comes to you, you eat it, and it's gone. When you think about annuities as a financial product, it's more like going to the grocery store.

Number one, you obviously still have to decide what you're going to eat, but you've got to decide what ingredients are going to go into it, very similar to some of the features you may be interested in with this financial product, or annuity.

Welcome to another episode of the Simply Retirement Podcast. I'm your host, Eric Blake. Joining me, as always, is Wendy McConnell. Wendy, how are you?

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

Eric Blake: I'm doing very well. We were talking about the weather before we hopped on here, and we're fortunate enough that it's been in the low 90s. We've got a little bit of rain too in the last few days, so it's been relatively nice.

Wendy McConnell: You sent your weather up to us here in Jersey, so thank you.

Eric Blake: You can have it. Don't send it back. That's all I'm going to say.

Wendy McConnell: We don't like 100-plus degree days here in Jersey.

Eric Blake: Yeah, that's part of the deal here in Texas, but we'll survive, as always. What's cool about this summer, it's a little bit different. I can't remember if I've shared this or not, but my daughter has moved back with her family. My granddaughter, who's two and a half now, started swim lessons this week.

Wendy McConnell: Okay.

Eric Blake: She has a private swimming instructor. It's at this lady's home, it's just her and a couple other girls, which is really cool. My wife was there, Don was there, and Caitlin was there too, and they were recording her doing the kicking and all this stuff. The instructor said, "She has no fear." I don't know if that's a good thing or a bad thing.

Wendy McConnell: Right, when we're talking about swim lessons. Yes.

Eric Blake: But she is enjoying it, to say the least. It's cool this year, and it's great that we can be this close to her now, to see her experience these new life events in her real life.

Wendy McConnell: You can just be on grandpa duty now. You don't have to actually take...

Eric Blake: Papa. You've got to get...

Wendy McConnell: Papa... care of her anymore.

Eric Blake: It's Papa.

Wendy McConnell: Sorry.

Eric Blake: It's important.

Wendy McConnell: Not to me it is.

Eric Blake: That's all...

Wendy McConnell: Right. Right.

Eric Blake: Hey, I never thought I would be a papa, but here I am.

Wendy McConnell: Hey, you know, you roll with the times.

Eric Blake: That's right. So last week we kicked off our four-part series on annuities by answering a simple question, or what I hope was a simple question, and that is, what is an annuity?

Wendy McConnell: Mm-hmm.

Eric Blake: And the bottom line is, we learned an annuity is simply a contract with an insurance company that's designed to provide income now or at some point in the future. More importantly, I think we introduced a question that I hope everyone is asking, and that is, what are you trying to accomplish? Because before you choose any financial product, any type of investment, it's important to understand what you're trying to accomplish, then decide whether that product is the right tool for that job.

Wendy McConnell: Okay.

Eric Blake: Right. And today we're going to build on that foundation by looking at the different types of annuities, but I do want to pause a bit. I want to come back to something you mentioned in the last episode. After we finished recording, I realized it's probably something some of our other listeners may be asking as well, or wondering. And you mentioned that when you hear the word annuity, in your mind you think of a stream of payments.

Wendy McConnell: Right.

Eric Blake: Right? Using the example of the lottery. So when somebody wins one of these big lotteries, they get the choice of, do I want the lump sum, or do I want payments over the rest of my life?

Wendy McConnell: Mm-hmm.

Eric Blake: Right? And I think that to some extent, that's where a little bit of the confusion comes in, because you're not wrong. And I'm going to share an analogy that I hope drives this point home a little bit. I told you, before we got started, this is either going to go really well, or it's going to fly like a lead balloon, and I'll let you know.

Wendy McConnell: We'll see how it goes.

Eric Blake: I'm sure you will, which is okay. But I think the confusion lies in thinking of an annuity as just a financial concept, and, as you said, like a stream of payments, versus what I would call an annuity in our case. What we're talking about in these episodes is a financial product.

Okay? Because with a financial product, I'm choosing to put my money into that product in return for some type of feature or benefit, but there are choices that come with that as I decide to put my money into that contract. And I want you to think about, the easiest comparison I wanted to make here, is thinking about a meal, okay?

You're going to go eat, you're hungry, or you just say, "We're going to go out to eat at some point." Thinking about it from the standpoint of, okay, if I'm just thinking about a financial concept, it's like going to a restaurant. The only thing I have to choose is what I want to eat.

Wendy McConnell: Right.

Eric Blake: Right? Maybe I'm going to eat inside or outside. But that's it. The food just comes to you, you eat it, and it's gone.

Wendy McConnell: Mm-hmm.

Eric Blake: Right? When you think about an annuity as a financial product, it's more like going to the grocery store.

Wendy McConnell: Ah.

Eric Blake: Because there are decisions that have to be made. Number one, you still have to decide what you're going to eat, but you also might have to decide what ingredients are going to go into that meal. Some people might like onions, some people don't like onions. I hate tomatoes, you might love tomatoes. But you've got to decide what ingredients are going to go into it, very similar to some of the features you may be interested in with this financial product, or annuity. And I think one of the things for you, the question you asked that I think makes some sense, is you also have to decide, if you're going to be making the meal, how long do you want to wait before eating?

Wendy McConnell: Okay. Bravo. I think that's good. Does that make sense? I think that's really good, Eric.

Eric Blake: So obviously you could say, "Well, I'm just going to buy the pre-made chicken that's already ready to go and eat immediately." That's one option. Or it might be, "Hey, I want something," this might be an overnight thing. I might be doing a stew, and I've got to put it in the pot, and it's going to sit overnight.

Wendy McConnell: Mm-hmm.

Eric Blake: But I've got to decide when am I actually going to eat this meal.

Wendy McConnell: Mm-hmm.

Eric Blake: Very much like an annuity. I could say, "Well, I'm going to turn on the income today," or, "I'm going to wait, and I'm going to turn on the income five years from now, 10 years from now, 20 years from now," whatever's appropriate for that situation.

So obviously, as you indicated, an annuity can refer to a stream of payments, which is actually something that when I was going through the CFP exam, or taking the CFP exam, or going through the education curriculum, that's one of the things we had to do, is say, "Well, what is the..." There are these payments, recurring payments over time. What's the present value of those payments? What would it be worth today? If I said, "Hey, I'm receiving an annuity, but some emergency came up. I need a lump sum for some reason, but all I've got are these payments."

Wendy McConnell: Okay.

Eric Blake: What would it be worth today if I said, "Hey, what if I could sell this thing, get a lump sum today, and somebody else starts receiving those payments?" I've got to know what that's worth.

Wendy McConnell: Okay.

Eric Blake: Right? But I think that's the correlation I would make, in terms of, again, back to the eating concept of saying, "Do I want to eat immediately, or do I want to delay and eat some point down the road, or is this a future order?" Right? Either way, you've got to make decisions on how you want to structure this thing. And again, very much like annuities, you've got to pick the features and benefits you're looking for. You've got to decide when you're going to start receiving income, and that's when we start getting into one of the other confusing things you mentioned, which was, okay, how does this accumulation phase versus annuitization phase work? How does that make sense?

Wendy McConnell: Right.

Eric Blake: Well, so back to our food conversation, the annuitization phase is basically what we just said. I'm eating, I'm going to go pick up something to go, and I'm going to eat it right now.

Wendy McConnell: Okay.

Eric Blake: That's also considered what I would call the annuitization phase. It's immediate, I've given the insurance company my money, and immediately in return they're going to start paying me an income.

Wendy McConnell: All right.

Eric Blake: That's the annuitization phase.

Wendy McConnell: Gotcha. So the annuitization phase, then, is just when you start receiving the payments.

Eric Blake: Yes. Exactly.

Wendy McConnell: Gotcha.

Eric Blake: Then the accumulation phase, again, back to our food example, is saying, "Okay, well, I'm going to start this process today, but I'm not actually going to eat this until tomorrow." So accumulation, and in the meantime, I've got to figure out what temperature I need to cook this at, right? Is it going to be a slow cook, or a quick cook? Are you going to be like me and say, "Well, what if I turn the heat up a little bit, maybe I can go a little bit faster, I can get this thing done a little faster."

Wendy McConnell: Yeah, that's what I do, and I burn everything.

Eric Blake: Right. But that's, again, what I think hopefully leads us into the types of annuities conversation, because for that exact same reason, am I the person who likes to be slow, the slow cooker, take my time, let it sit there and do whatever it's going to do? Or am I somebody who wants it to go really fast, right?

Wendy McConnell: Okay.

Eric Blake: And that's going to lead us to the types of annuities. So again, you weren't wrong about what you thought an annuity was, but that's where we say, okay, what's the difference between the concept of an annuity being just a payment, a series of payments, versus a product that I'm deciding to put money into in return for something I'm going to get, some type of feature, some type of benefit, some type of guarantee in most cases. With an annuity, there's always going to be some amount of guarantee, whether that's related to the income, a death benefit, or even the interest I'm going to earn, right? And that's when we start thinking about the financial product, and what are the different types of annuities that are out there that I might be able to choose from.

And then, what are the decisions that come along with that? So the first thing is, you think about when you want that income to start, right? So there's always an income element to it. Now, there might be some other features to decide on, but ultimately there's an income component to this.

Wendy McConnell: Mm-hmm.

Eric Blake: And the second thing is, if income isn't starting today, how do you want your money to work for you while you're waiting? Again, do I want a high temperature or a low temperature? How fast do I want this thing to cook?

Wendy McConnell: Okay.

Eric Blake: Right. So when we think about the decisions, when do you want to start income, let's start with the first question, and then that'll lead us into the different types of annuities that might be available to you. So the first question is, do you need income now, or are you planning to take income later? If your priority is creating income today, you're going to be looking at something called an immediate income annuity.

Wendy McConnell: Okay.

Eric Blake: That might be worth considering. With an immediate income annuity, you generally make a lump sum payment to the insurance company, and in return, that insurance company begins making income payments back to you, often within a month, although some contracts begin a little bit later. But the goal, ultimately, is income right away.

Wendy McConnell: So I'm eating the meal right away.

Eric Blake: Exactly. There's little to no accumulation phase. We're not letting this thing sit there and earn interest or do anything else, because our purpose is creating income, right? So the focus isn't on growing money, the focus is creating income. And one question I hear quite a bit is this: how does an insurance company decide how much I'm going to receive? And the answer is actually pretty straightforward. It's based mainly on how much you're putting in, of course. When do you want payments to begin? What's our current interest rate environment? And are there any other guarantees you might choose to have as part of this contract? So, in general, the older you are when the income begins, the larger your payment's going to be, because the insurance company expects to make those payments over fewer years.

Wendy McConnell: Okay.

Eric Blake: Right? So if it's a lifetime payment, and I'm 70 versus somebody who's 50, the 70-year-old is going to receive a higher lifetime payout because they've got less time to live, right? That's what some of these decisions are going to be based on. And we're going to spend much more time talking about the guarantees in our fourth episode, because that's where they can affect both the income you're receiving and some of the costs that might be associated with the annuity you're purchasing.

Wendy McConnell: All right.

Eric Blake: Now, the trade-off with an immediate annuity is that you're generally giving up access to the lump sum you used to purchase the annuity contract.

Wendy McConnell: Okay.

Eric Blake: Right? So if I put $100,000 into an annuity, I really think of that $100,000 as no longer mine, it's the insurance company's. But in return, they're going to start paying me some amount of money for the rest of my life, over a 10-year period, over a 20-year period, whatever the terms of that contract might be, right? So for someone whose goal is creating income today, that may be exactly the right trade-off. But what if you don't need income yet? Maybe you're still working, or maybe you've already retired and you have enough income currently from Social Security, a pension, or other savings. You know you'll need additional income later, you just don't need it today, right? That's where something called a deferred income annuity, or DIA as you might hear it called, comes into the conversation. A deferred income annuity has the same purpose as an immediate annuity, the difference is simply when the payments are going to begin. So instead of starting income shortly after you purchase it, you choose a future date, and that future income amount is determined in much the same way, okay? It's based mainly on how much you put into the contract, when your payments are going to begin, interest rates, and again, any guarantees you might choose. Now, one additional factor is how long you wait before those payments begin. In general, the longer you defer the income, the larger those future payments are expected to be.

Wendy McConnell: So it's like planning Thanksgiving dinner now.

Eric Blake: Yes.

Wendy McConnell: Okay.

Eric Blake: Exactly. That's perfect. So this food thing is going to work really well. I'm going to use this...

Wendy McConnell: Let's...

Eric Blake: ...keep it going. I came up with this at the gym this morning, I'll just be honest. I came up with this idea at the gym. I was like, "How can I make this thing sink in?" Food. Food is always the right answer.

Wendy McConnell: Food's always the right answer, yes.

Eric Blake: So in the case of the deferred income annuity, again, the objective isn't simply to grow your money, the objective is to create income later on in retirement. But a deferred income annuity isn't the only financial product that can provide income later. That's where we're going to get into the next... what I would call... You've got a deferred income annuity, and I want to make sure I'm clear on this. So there's the deferred income annuity, which, again, we're basically saying, and we actually have a client who did this probably a handful of years ago now, and every year we're looking to say, "What is the current projected income when your start date is set?" In this case, they had the option of saying, "Do I want income to start at 65 or 67?" And they had a little bit of flexibility to say, "Well, I'm not going to retire at 65, I'm probably going to be retiring closer to 67 or 70." They had the choice to say, "I'm going to defer it just a little bit longer." Now, you don't get a lot of choices in these cases when we're talking about deferred income, but in this particular case, that was one of the things they did have access to.

Wendy McConnell: Okay.

Eric Blake: But these are, again, talking about income-based annuities, where the purpose is, in fact, income, okay?

Wendy McConnell: Got it.

Eric Blake: Hi, 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 really valuable. If you've ever asked yourself, "How much is my Social Security reduced if I file early?" Or, "Am I eligible for benefits as a spouse, surviving spouse, or even after divorce?" You're not alone. That's why we created our ultimate guide to women's Social Security success. It includes six of our most popular Social Security guides and checklists for women. Inside, you'll find a 2026 quick reference guide with key Social Security amounts and limits to be aware of, along with five additional guides and checklists to help you make more informed decisions about eligibility and filing strategies. You can download it for free at womenssocialsecurityguide.com. Keep it handy wherever you may be in the decision-making process.

Now back to the episode. Then we start talking about what I would call deferred annuities. Not deferred income, but deferred annuities, okay? This is where we're actually putting our money into a contract, and before we turn that income switch on, our money is going to be working for us.

Wendy McConnell: Okay.

Eric Blake: Right? And the difference is that they give you choices. You're going to have choices about how your money works during the accumulation phase, okay? So annuitization is income, accumulation is, again, this deferral period where the money is actually working for you until you flip that income switch on, okay? So the question now is, how do you want your money to work while you're waiting?

Wendy McConnell: Yep. How do I want it to work?

Eric Blake: So if you don't need income today, your money's going to spend some time in the accumulation phase. So then the next question becomes, again, how do you want your money to work while it's in there? And the way I would think about these types of annuities is, and I'm going to get away from the food analogy for just a second. We could probably tie it in, but I already had this kind of in my mind, how I'm going to do this. In this case, we're going to talk about automobiles, okay?

Wendy McConnell: Mm-hmm.

Eric Blake: They're all designed to get you where you're going. Again, there's going to be income at some point down the road, we just haven't decided when yet. But if you think about a car, they're all built differently because drivers have different needs, right? Some people want fuel economy, others might have a large family, others might just be focused on performance. So none is automatically the best choice, it depends on what you need that vehicle to do for you. Annuities are very much the same from that perspective. They're all designed to make income possible at some point, the difference is how they get you there, okay? So let's start with the simplest of these options, something called a fixed annuity, okay? So if predictability is your priority, a fixed annuity may be a good fit, okay? With a fixed annuity, the insurance company credits a stated interest rate for some period of time. It might be three years, it might be five years, it might be seven years. You know how your money is expected to grow over that time period. That's the biggest advantage. So if I get an annuity contract that's going to guarantee me a 4% interest rate, for example, over five years, I know what I'm going to receive, I know what's going to be there at the end.

Wendy McConnell: So it's like a CD.

Eric Blake: Very much like a CD, except for the tax deferral. So again, in episode three, we're going to talk about the tax implications. We're earning like a CD, but I'm not having to pay tax on the earnings as it's growing.

Wendy McConnell: Okay. I'm always skipping ahead, you know that.

Eric Blake: Yeah, I know, but you always set me up too, that's good, that's all right. But actually, as you can expect, the trade-off is that you're giving up some growth potential if the market performs really well. We've seen the market do extremely well over the last several years, that's what you're giving up to some extent. Now, again, if you're risk-averse, if you're just a conservative person, you might not necessarily think of that as a trade-off. But again, the idea behind a fixed annuity is, I know what I'm getting after some period of time.

Wendy McConnell: Okay.

Eric Blake: Now let's look at our next type of annuity. This is where we say, okay, perhaps you're looking for more growth potential, but at the same time, you're uncomfortable exposing that money directly to the stock market and potential losses, okay? That's where a fixed indexed annuity may fit, okay? With a fixed indexed annuity, your money isn't invested directly in the stock market. Instead, it's connected, or tied, to the performance of a market index.

Wendy McConnell: Okay. And what is a market index?

Eric Blake: So think about when you look at the news, most of us see the Dow Jones, or the S&P 500, or the NASDAQ 100, whatever those different things are that scroll across your screen that most people shouldn't be paying attention to.

Wendy McConnell: But they do.

Eric Blake: I understand, I understand. But the S&P 500 is an index. So that's an index of the largest 500 companies in our country, simply put. So with a fixed indexed annuity, my performance is tied to that. If the index performs well, your annuity may receive part of that growth. Now, you're never going to get all the growth and none of the risk. There's nothing out there that does that, right?

Wendy McConnell: Can we create something like that?

Eric Blake: Create something like...

Wendy McConnell: Yeah, that'd be really cool.

Eric Blake: ...that. You might be able to, but the cost might be pretty extensive. So that would be the challenge.

Wendy McConnell: Okay.

Eric Blake: But again, you're participating in the market performance, you're getting some of the upside, but you're trading off all the upside for some amount of protection on the downside. So if it's just a traditional fixed index annuity where maybe I have a cap of, say, 7%, just as an example, the market does 15, I get 7. If the market does 5, I get 5. But if the market loses 15, I get 0.

Wendy McConnell: Okay, I gotcha.

Eric Blake: So you're participating in the upside while protecting your principal on the downside. Now, that means you may not necessarily lose value because of the market, but you'd want to be aware of fees. And again, we're going to expand on fees and costs and things like that for annuities in our fourth episode of this series. But the bottom line here is, with a fixed index annuity, you have the opportunity for some of the upside of the market without the downside.

Wendy McConnell: Okay.

Eric Blake: Okay? So you don't need to understand all those details today, we're going to talk about some of these other, more specific contract features, costs, things like that, in a future episode. But again, a fixed index annuity is designed to provide more growth potential than a traditional fixed annuity, while helping reduce the impact of market declines.

Wendy McConnell: Yes, I like that.

Eric Blake: Now let's look at the other end of the spectrum. If you're comfortable accepting more investment risk in exchange for greater growth potential, a variable annuity may be worth considering.

Wendy McConnell: Mm-hmm.

Eric Blake: With a variable annuity, your money is invested in underlying investment options. Maybe think of it kind of like your 401(k), you've got to pick some funds you're going to invest in. In an annuity, they're actually called subaccounts, but it's very similar to a mutual fund. If they don't do well, then your account value may decrease. But if those investments do perform well, your account value may increase, based on how aggressive or conservative you are within those allocations. But again, the opportunity for greater growth comes with greater investment risk.

Wendy McConnell: Right.

Eric Blake: Right? But now you can probably see why there isn't one annuity that's best for everyone, because each type is designed to solve a different retirement planning challenge. And that's why I keep coming back to that same question we've asked throughout this series: what are you trying to accomplish?

And I think one of the things to think about, with the variable annuity, is there are some people who, if they have a higher risk tolerance, maybe they're at a higher tax bracket and they're just looking for more opportunities for their money to grow, but I come back to that tax component and tax deferral. Some people say, "Well, why would I choose a variable annuity?" Right, it could simply be because I don't want to pay income tax on the income as my assets are growing, and that's where a variable annuity may give you that upside opportunity. You can be as aggressive or as conservative as you want to be, but those earnings stay tax-deferred. They stay inside that annuity until you get ready to withdraw those dollars.

Wendy McConnell: Okay.

Eric Blake: Now, once you can answer that question, what are you trying to accomplish, it becomes much easier to determine whether an annuity belongs in your retirement plan, and if it does, which type may be the right tool for you.

Wendy McConnell: Mm-hmm.

Eric Blake: Right? So by now, hopefully this has become a little bit more understandable.

Wendy McConnell: It has.

Eric Blake: Different annuities exist because there are different retirement goals that require different solutions. So as we bring everything together, the first question is always going to be: do I need income now, or do I need it later? Then, if income will begin later, you ask yourself, "Well, how do I want my money to work while I'm waiting for that income to start?" These two questions will narrow your choices considerably. And remember, the objective isn't to find the best annuity, the objective is to determine whether an annuity belongs in your retirement plan at all, and if it does, which type is the right one for you.

Wendy McConnell: All right.

Eric Blake: Right? So before we finish, there's one more point I want to make, and that's that every annuity we've discussed today can generally be owned inside an IRA as well, okay, or purchased with after-tax dollars outside of a retirement account.

Wendy McConnell: Do you mean that I can use money from my IRA to purchase an annuity?

Eric Blake: Yes.

Wendy McConnell: Okay.

Eric Blake: Yep. And we're going to tie the tax component to that in the next episode. With IRAs, because they're already tax-deferred, you don't get extra tax deferral because they've got an annuity as well.

Wendy McConnell: Right.

Eric Blake: Right. There's no extra bonus tax deferral.

Wendy McConnell: Double savings.

Eric Blake: That's right. But the type of annuity doesn't determine how it's taxed, it's how you own it that does, right? And that's exactly what we're going to cover in the next episode. We're going to explain how annuities are taxed, the difference between owning an annuity inside an IRA versus purchasing one with after-tax dollars, and, of course, why understanding that distinction can help you make better retirement planning decisions.

Wendy McConnell: All right.

Eric Blake: If you'd like help organizing your thoughts, I encourage you to download the free companion guide that we're going to be including in the show notes for this episode. It's called Does an Annuity Fit Within My Financial Plan? Again, one of the reasons I like this is because it helps you ask the right questions. Instead of starting with a product, or do I need an annuity, do I not, it starts with what you're trying to accomplish. So once you answer that question, it becomes much easier to determine whether an annuity does belong in your retirement plan or not, and which goals you may be trying to accomplish with that particular product. And you can download that at thesimplyretirementpodcast.com.

Wendy McConnell: Okay.

Eric Blake: All right. Well, hopefully this was helpful. Hopefully this cleared up a little bit of the confusion we had from the last episode.

Wendy McConnell: Made me hungry too.

Eric Blake: Actually, that's perfect. For us, it's lunchtime. So you're already past lunch.

Wendy McConnell: Oh, no I'm not.

Eric Blake: Oh, okay. Are you still going to cook something? Are you going to go to a restaurant?

Wendy McConnell: I'm going to make something. It's going to take a while too.

Eric Blake: There you go. So you've got a deferred food option there.

Wendy McConnell: Yeah.

Eric Blake: Deferred annuity, deferred food option.

Wendy McConnell: Yep.

Eric Blake: Well, awesome. Well, that is it for today's episode. As always, thank you for tuning in. Thank you, Wendy, for joining me once again as well. For all the links and resources mentioned today, including the free copy of Does an Annuity Fit Within My Financial Plan?, visit thesimplyretirementpodcast.com. Don't forget to follow our show so you don't miss the next episode, where we talk about taxation of annuities.

And until next time, please remember, retirement is not the end of the road. It's the start of a new journey.