Should You Buy Annuities, and Are They Good Investments?
- 3 days ago
- 12 min read
We get a lot of questions about annuities in our online physician community, especially from doctors who have been pitched annuities as tax-advantaged investment vehicles by financial advisors and insurance agents. While annuities can have special taxation considerations that may be beneficial to doctors in certain situations, not all annuities are created equally, and the tax benefits may not make up for the long-term growth potential that is given up by not investing that money into other investment options. Annuities at their core are insurance products that protect the insurance company’s investment as much as your own, so it’s important to understand how they work, and when they may or may not make sense, which we cover below.
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What is an annuity?
An annuity is a contract with an insurance company where you make premium payments over time or a single premium payment upfront. In exchange, the insurance company provides regular payments back to you in one of two ways:
An immediate annuity begins paying you income right away
A deferred annuity (more common) starts distributing payments at a later time, usually several years or decades later once you’ve reached retirement age
Annuities are insurance products provided by insurance companies. The insurance company providing the annuity generally pays a commission to the agent that sells it to you, and these commissions can be large, as we discuss below, introducing conflict of interest for the person selling them to you.
Generally speaking, what are the pros and cons of annuities?
We’ll dive into the details below as the nuances depend on the specific product, but generally speaking, these are the pros and cons of annuities.
Benefits of annuities
‘Guaranteed’ income - some will be for life, some will be for a fixed term, but many like the fixed payout aspect of these products as they allow you to plan for retirement with a more concrete idea of cashflow. We discuss below the risks of ‘guaranteed,’ as it does depend on the insurance company issuing the product being financially sound and back up measures insuring the full amount.
Potentially tax advantaged growth - while the exact tax benefits depend on the specific product, depending on the account holding the product, there can be some component of tax advantaged growth
Loss limitations - unlike traditional stock market holdings, depending on the product, you’re either guaranteed to get a certain payout or you’ll have downside protection against losses
Options customizable to your situation - like most insurance products, there are riders that can be beneficial or customizable to your particular situation
No defined contribution limits - unlike retirement accounts, there are no contribution limits to annuity products, allowing you to put as much as you want into them
May be asset protected - depending on the state that you’re in, annuities can be protected from lawsuits
Downsides of annuities
High fees - depending on the particular annuity, fees will vary, but it’s important to know there are significant fees associated with most of these products that will erode away at returns
May have a higher net worth if you invest the money instead of buying the annuity - there’s several x factors here because of the uncertainty of how many years you’d collect the annuity, but remember this is an insurance product that they wouldn’t be underwriting unless they thought they’d come out ahead
Limited liquidity - once your money goes in, you usually won’t be able to access it for a long time
Complex product that can be difficult to understand - although the salesperson may make it sound simple, it can be difficult to understand the nuances of each of these products, their taxation, and the returns they’ll generate
Taxation upon withdrawal - unlike long term capital gains from your long term holdings in the stock market, many of the payments and/or growth paid out by these products are subject to ordinary income tax, which for many doctors, is higher than the long term capital gains rate
Charges to surrender the product or if you withdraw early - this can vary based on when you take it out, and particularly if you surrender the product early, can be quite high. If you take money out before 59.5, there may be an IRS penalty on earnings.
The issues with annuities, and why it’s not straightforward if they are good investments
Although we outlined the pros and cons above, many in the personal finance space recommend staying away from annuities except in special circumstances. Unfortunately, annuities are often pitched to physicians through insurance agents and financial advisors because of the commission structure available to them for selling annuities. These commissions can be significant (generally in the 1-10% range), which can skew the incentives of the agents selling them to recommend them, even if not the best fit for your specific retirement and investing goals.
While commissions are built into what you pay for an annuity–and the resulting payments you receive after–annuities may also be subject to additional fees and charges, which can make them even more expensive.
As such, the returns you can get from an annuity are often much lower than what you could otherwise make with the contributions, should you choose to directly invest them into the stock market yourself.
Should you buy an annuity, and when does buying an annuity make sense?
Annuities are conservative vehicles by definition, as they’re a hybrid investment strategy and insurance policy to protect your contributions. While most investment gurus are not a fan of mixing investment and insurance because you’d typically come out ahead by just investing the money and not having the fees associated with these products, there are some situations where you may consider an annuity worthwhile, including:
If you have a need for predictable income / cashflow in retirement
You’ve already maxed out all tax advantaged retirement accounts and want to put more towards retirement
You haven’t saved enough for retirement and you’re worried about outliving your savings.
While you’re generally better off taking what you’d pay in contributions and investing them yourself, annuities –especially fixed annuities– are good at providing stable, reliable income when it’s needed in retirement. This can be handy for physicians who don’t understand the stock market (and don’t want to take the time to) and who haven’t been investing because they’re afraid of losing their principal. At the end of the day, some investing, even with higher fees, is better than no investing and leaving cash sitting in a bank account, where you lose purchasing power against inflation. An annuity can help reduce stress and worry about outliving your money, and can act as a personal pension, if you structure the annuity appropriately and choose a lower fee option.
An annuity may be something to also consider if you’ve already maxed out all your other tax-advantaged investing options, especially if you live–and plan to stay–in a state that offers strong protections against creditors.
If you’re looking into annuities because you aren’t comfortable investing in the stock market yourself, consider working with a robo advisor or a financial advisor to help you navigate the market and investment options.
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Do annuities protect assets from lawsuits?
Annuities can offer protections from creditors, but the protections offered vary significantly from state to state. With an annuity, you are essentially removing funds for your direct assets and placing them under the control of the insurance company. This can help protect the cash value of the annuity and the future income payments from seizure, though again, the protections depend heavily on the laws in your specific state.
In some states, annuities are unconditionally exempt from seizure by creditors, or in bankruptcy. Other states offer limited protections, such as caps on the protection limits, or offer protections only on certain types of annuities.
We highly recommend talking to a professional, such as an estate planning attorney, in your state to understand the protections in place.
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Are annuities safe investments?
One of the benefits of annuities is that they offer stable returns for predictable income in retirement. The exception here is variable annuities, which may not offer as many guarantees on returns.
Guaranteed returns, however, are only guaranteed if the annuity–and the company offering it–are around. Investing involves inherent risk in returns for the rewards of the growth on the invested contributions. Annuities are no exception. While annuities can be more stable than investing in mutual funds and stocks, and have some protections in place, they do still carry risks.
A couple key considerations to know:
Annuities are primarily backed by the insurance company offering them. If considering an annuity, along with deciding what type is a good fit, also consider the insurance company providing it. Look for large, highly rated insurers with a long track record, as these are more likely to be stable.
Each state has a Guaranty Association, which insures policies should the insurance company go bankrupt. Coverage limits can depend on the specific state, but most states provide around $250,000 in annuity value per person.
As annuities are insurance projects and not funds held with banking institutions, they are not FDIC insured.
What are the different types of annuities?
Annuities can be categorized as fixed, indexed, or variable.
Fixed annuities provide premiums of a fixed amount guaranteed by the annuity contract based on interest rates set by the insurance company in the contract.
Indexed annuities are a type of fixed annuity where the returns are determined by the performance of a market index, such as the S&P 500, though only a predetermined portion of the performance adds interest to your annuity.
Variable annuities let you decide how the insurance company invests your premiums (less the fees and charges they take out). The amount of your income payment can be either fixed (set at the beginning of distribution) or variable (changes with the value of your investments).
Annuities can also be categorized as qualified or non-qualified, which can impact how they are taxed (see below).
A few specific common annuities types are:
Single Premium Immediate Annuity (SPIA)
This is an immediate annuity where you give the insurance company a lump sum and they start making monthly payments to you every month during your selected annuity term. These payments usually begin within one or two months of funding.
A SPIA term can be for a fixed period of time, such as 10 or 30 years, or for the remainder of your life. The payments are guaranteed during that term, but there is nothing provided to any beneficiaries after your passing.
Your monthly income amount is based on factors such as:
Your age
Your gender
Your payout terms
Current interest rates
The amount you invest
Deferred Income Annuity (DIA)
With a deferred income annuity, you fund the annuity now, but wait for payments at a set time frame in the future, typically during retirement. The longer you wait to get payments under a DIA, the higher the payment amount becomes:
If you delay your payments over a longer time period (i.e. wait 30 years for payments instead of 10 years), your payments can be significantly higher for the same initial investment.
If you decide to fund a DIA later in life (such as at age 70 versus age 60), your payments can be significantly higher for the same initial investment and the same delayment time period until receiving payments.
Most deferred income annuities have some sort of guarantee against the loss of the principal amount you pay into the annuity, and typically also offer a guaranteed rate of return. This is more generally applicable to fixed rate annuities; variable annuities are less likely to have as many protections in place.
Qualified Longevity Annuity Contract (QLAC)
A QLAC is a special type of deferred income annuity that is held within a retirement account such as an IRA or 401(k). With its special status come a few guidelines that govern it. A QLAC:
Must be a fixed rate annuity (variable and indexed annuities don’t qualify)
Has a limit on how much you’re allowed to invest (up to $210,000 per person as a lifetime limit, as of 2026)
Payments must begin by age 85
By funding a QLAC, you typically delay payments until around the age of 75 - 85. As with a DIA, the longer you wait to start payments, the higher the payments you’ll receive.
One of the advantages of a QLAC is that the amount you put into a QLAC is not counted toward calculations for Required Minimum Distributions (RMDs).
Multi-Year Guaranteed Annuity (MYGA)
A MYGA is a type of fixed annuity that locks in a guaranteed rate of return for a specific term, such as 3, 5, or 7 years. A MYGA is similar to a fixed-rate CD offered by a banking institution, though the taxation for annuities can be different, as we highlight below. With a CD, interest is taxed as income when it is earned. With a MYGA, the interest can be left to compound tax-deferred inside the annuity. A MYGA can also be exchanged for another MYGA at the end of the term, repeatedly, which can continue to defer taxes.
Similar to a CD, this may be something to consider as a short-term investing solution–and may offer a better rate than a CD–to help protect your principal investment.
Related PSG resource:
How are annuities taxed?
The taxation of an annuity depends on what type of annuity you have and where the annuity is held. There are two types of ways annuities are classified that play into taxation considerations: qualified annuities and non-qualified annuities.
Qualified annuities
A qualified annuity is funded with pre-tax dollars. These annuities are typically held in a retirement account such an IRA. Taxes on qualified annuities are deferred until funds are withdrawn. Payments provided through a qualified annuity are generally taxed as ordinary income. Contributions may reduce your taxable income in the year they’re made, though they are subject to the rules governing contributions to the type of retirement account it’s held in, including related income limits. For example, if your annuity is held within a traditional IRA, most doctors earn higher than the income limit for a deduction.
Qualified annuities are typically set up by transferring money inside a 401(k) or IRA into the annuity. The annuity doesn’t offer any additional tax deductions compared to the retirement plan you withdrew the funds from; the annuity keeps the same taxation status in place for the retirement assets used.
Non-qualified annuities
A non-qualified annuity is funded with after-tax dollars. If you have a non-qualified annuity within a Roth account, such as a Roth IRA, the entire payout is tax-free.
If you have a non-qualified annuity outside of a retirement account, since you’ve already paid taxes on the contributions that go into the annuity, you only owe taxes on the earnings the annuity generates as it grows. You are not taxed again on the contributions you made.
Taxes on payments received from a non-qualified annuity outside of a retirement account are determined using an exclusion ratio that compares the interest portion of your payment (which is taxed at ordinary income rates) to the principal amount contributions (which is tax free). The exclusion ratio can depend on factors such as:
The contributions made into the annuity
How long you’ve have the annuity
The interest rate of the annuity
If you withdraw a lump sum from the annuity outside of the scheduled payments under the annuity terms, these are taxed under a different “last in, first out” (LIFO) situation that assumes you’re primarily withdrawing the growth before your contributions.
Given the complexity of the different taxation situations on annuities, if you are considering an annuity, we recommend working with an accountant or tax strategist to make sure you understand the specific tax implications for the annuity you’re considering.
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Penalties for early withdrawal
Withdrawals from annuities held within a retirement account that are taken before 59 ½ years of age may be subject to a 10% penalty by the IRS on the taxable portion, on top of any income taxes owed.
Conclusion
While most doctors are likely better off in terms of return on investment when they invest the funds they’d put into an annuity by themselves instead, there are a few situations where an annuity can be a good financial planning strategy, depending on your specific situation and risk tolerance level We highly recommend working with skilled professionals to help you walk through your investment and tax planning to find the best fit for your particular situation. When reaching out to a financial advisor for guidance, do not ask a financial advisor who sells annuities. As covered above, they can have skewed incentives for these products. We recommend getting the advice of a fee-only advisor versus a fee based advisor, as fee based advisors take commissions on products.
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