An annuity is a financial product that has one or both of the two main features: 1) tax-deferred growth; 2) guaranteed income for a number of years or lifetime. Annuities offering just the first feature (tax-deferred growth) are called investment-only annuities. Annuities offering just the second feature (guaranteed income for a number of years or lifetime) are called immediate annuities. Annuities offering both features (tax-deferred growth and guaranteed income) are called deferred annuities.

Investment-Only Annuities are used primarily for investment with tax-deferred growth. They have the potential to beat taxable accounts, on after-tax and after-cost basis, as taxable investments incur a lot of tax cost. A recent study from Morningstar shows that the average stock investor loses 2% on growth rate each year to taxes in a taxable account.

After a number of years of investing tax-deferred, an investor may transfer the money from one annuity to another without incurring taxes (like IRA rollover), if the new annuity offers better investment potential. This is called the 1035 exchange, under the IRS code 1035.

For immediate annuities, an investor pays a sum of money and the annuity company turns it into a stream of income immediately. The income may last a pre-set (say 10 or 20) number of years, lifetime for one person, or lifetime for two people (until the second annuitant passes away).

Immediate annuities are like a traditional pension which typically provides a fixed amount of income each year (not inflation-adjusted). In addition, they typically do not provide much death benefit. Immediate annuities are becoming less popular due to such limitations.

For deferred annuities, the policy owner lets the money grow for a number of years on a tax-deferred basis (this period is called the accumulation phase), and then turns it into periodic income for a number of years or lifetime (this period is called the payout phase or distribution phase). Many deferred annuities offer income riders that provide guaranteed minimum investment return and pre-set payout rates for periodic income. They typically offer death benefit in case the policy owner or annuitant dies prematurely. The periodic income may also increase year after year.

To appreciate the value of a deferred annuity, we would need to think about what our retirement income planning will be without it. Imagine that we have saved a big sum of money and need now to withdraw some money each year after retirement. How much money should we withdraw each year? If we withdraw too much, the money may not last our lifetime. If we withdraw too little, we are not making the best use of our hard-earned money to enjoy life. Retirement experts have a rule of thumb which is called the 4% rule. That is, if we withdraw 4% of our savings in the first year of retirement and adjust it for inflation in future years, there will be a 90% chance that our money will last for 30 years, provided that our investment is in a 50-50 portfolio, based on historical stock and bond returns in the USA.

If an annuity can offer withdrawal amounts larger than what the 4% rule provides, then the annuity would be worth considering, as annuities can have guaranteed (not just a 90% chance) income for life (not just 30 years). In doing so, we transfer our market risk and longevity risk to annuity companies. Two hard issues in retirement planning are that: 1) we do not know how many years we will live in retirement (longevity risk), and 2) how the stock and bond markets will perform in the future (market risk). Using the 4% rule alone could cause us to run out of money. In addition, the insurance feature of an annuity ensures that you get more money out of an annuity if you live longer than the average.

For investment-only annuities and the accumulation phase of deferred annuities, there are three investment styles that we can choose from:

1. Variable annuities typically provide many sub-account funds (mutual funds or ETFs) for investors to construct a diversified portfolio, which may include domestic and international stock, bond, balanced, real estate, and health care funds, etc.
2. Index annuities offer downside protection as well as upside growth potential. Their performance is linked to the returns of stock market indexes. When the stock market is down, index annuities may provide a floor or buffer to help protect against market lose. When the stock market is up, the money in such annuities may grow with or without a pre-defined limit.
3. Fixed annuities offer a fixed rate of return for a number of years, which are similar to bank CDs but typically have higher rates than bank CDs.

Annuities funded with regular after-tax money are called non-qualified annuities. Their tax treatment is different from traditional IRA annuities (funded from traditional IRA money or 401k rollover), and Roth IRA annuities (funded from Roth IRA money or Roth 401k rollover). The investment gains from withdrawals or periodic annuity payouts from non-qualified annuities and all withdrawal amounts from pretax traditional IRA annuities are subject to ordinary income taxes, while withdrawals from Roth IRA annuities are tax-free. If the withdrawals are before age 59.5, there is also a 10% IRS penalty, unless they meet IRS exceptions such as being Substantially Equal Periodic Payments (SEPP), under IRS code 72. Thus, annuities are designed primarily for retirement investing.

If used properly, annuities can provide at least the following benefits to us as an investor and retiree:

1. Accumulate more wealth using its tax-deferred growth feature.
2. Enable us to have more income to spend in retirement than what the 4% rule or a Monte Carlo method provides.
3. Guarantee lifetime income no matter how long we live. We face many uncertainties in retirement, including not being able to predict how many years we will live. Guaranteed income for life can add some certainty and quality to our retirement lives.
4. Have a peace of mind in retirement. The #1 worry among retirees is running out of money, not deteriorating health. In the late stage of retirement, most retirees see the balance of their savings account declining or diminishing and start to worry. Guaranteed income to cover living expenses for life will make us not to worry and lose sleep.
5. Have a good financial life even when we cannot make sound financial decisions. 33% of people older than 85 have dementia. When we are too old to think logically, having guaranteed monthly income deposited to our bank account will be the best financial decision we have ever made in our lives.

Advisory annuities are fee-only (no commissions involved) annuities that are sold and managed by Registered Investment Advisors (RIA) who have a fiduciary duty to act in the client's best interest, mandated by the law. Unlike commission-based annuities, clients may pay different costs at different RIAs for advisory annuities. If you buy advisory annuities from us, we guarantee that you will pay a noticeably lower cost compared against commission-based annuities with identical features. For example, the commission-based annuity: Allianz Index Advantage Income Variable Annuity costs 21.8% more than its advisory annuity counterpart: Allianz Index Advantage Income ADV Variable Annuity, if bought from us.

Many annuities have no cost, in the same way that we do not pay a cost when buying stocks or bank CDs. However, many other annuities have cost. To decide if an annuity adds value, we need to consider whether its benefits are larger than its cost. For an investment-only annuity, does its tax-savings and investment return outweigh its cost? For an income annuity, can we get more income from the annuity than managing income withdrawals ourselves (using the 4% rule or a Monte Carlo method)? We provide free data analysis to help you decide if an annuity is good for you.

The following articles may provide more understanding on annuities and the 4% rule.

1. Annuities As A Personal Pension
2. Will You Run Out Of Money In Retirement?
3. How An Annuity Improves A Retirement Plan
4. Annuities Have Long Gotten a Bad Rap. Retirement Experts Now Say Savers Should Consider Basic Options for Guaranteed Income
5. The 4% rule is being debated — again — but here’s what you should do
6. What is the 4% rule for retirement withdrawals?

Registered Index-Linked Annuities (RILA) are also called variable index annuities. Since they were introduced in 2010, RILA sales have maintained a 38% compound annual growth rate. In particular, RILA sales for the first half of 2021 were 105% higher than the same period in 2020.

Why is this new product getting so popular? While fixed index annuities are designed for stable growth with 100% downside protection (even when the market is down 50%, your money will not decline), RILAs are designed with specific features to promote greater asset growth potential while providing a level (typically not 100%) of protection from volatile markets. In fact, RILAs offer the highest accumulation potential among risk-managed annuity products. Many RILA products are investment-only while many others offer lifetime income as well.

• The annuity owner is the person who invests the premiums and has the authority to make withdrawals, change the beneficiaries and terminate the annuity contract, etc. Non-qualified annuities may have a joint policy owner.
• The annuitant is the person whose life determines the annuity payouts for lifetime income. Annuity companies use the annuitant's age, gender, and life expectancy to calculate the periodic payouts from an annuity. The annuitant is the policy owner in most cases. A joint annuitant (typically a spouse) may be allowed. A joint and survivor annuity payout guarantees that income payments last for the duration of the life of the second annuitant. If a long-term care rider is associated with an annuity, it covers the care for the annuitant.
• The beneficiary receives the death benefit of the annuity. Primary and secondary beneficiaries may be designated. If beneficiaries are designated properly, annuity proceeds will not go through the probate court.