Some financial advisors promote annuities because they offer tax deferral, guaranteed income, or principal protection. But while these features can support retirement planning, annuities often carry high fees and commissions that can influence recommendations. Knowing why advisors recommend annuities can help you ask better questions and evaluate how this option could fit into your financial goals.
What Is an Annuity?
An annuity is a financial contract typically offered by an insurance company. It’s designed to provide a stream of income in exchange for an upfront payment or a series of contributions. Some annuities begin payouts immediately, while others start at a future date. The basic appeal is predictable income, but the structure and terms can vary widely.
There are several types of annuities. Fixed annuities offer a guaranteed interest rate and set payments. Variable annuities allow the owner to invest in subaccounts tied to market performance, with income that fluctuates accordingly. Indexed annuities offer returns linked to a market index, with downside protection and a cap on gains. Deferred annuities delay payouts, while immediate annuities begin disbursing income shortly after purchase.
How Annuities Can Fit Into a Financial Plan
Annuities are often used as a tool for retirement income. Some people use them to supplement other sources of retirement funding, such as Social Security or pension income. The appeal lies in the ability to lock in a guaranteed payout for life or a set number of years, which can help reduce the risk of outliving savings.
Annuities also allow for tax-deferred growth. Investment gains within the annuity compound without being taxed until withdrawals begin. For individuals who have already maxed out other tax-advantaged accounts like IRAs or 401(k)s, an annuity can offer another avenue for deferring taxes.
Why Financial Advisors Recommend Annuities
Advisors may recommend annuities for clients who value income stability or have limited tolerance for market volatility. An annuity can function as a personal pension, offering peace of mind to individuals concerned about covering fixed expenses in retirement. This can be especially appealing for clients without employer-sponsored pensions or those who want to shift away from growth-oriented strategies in later years.
In some cases, an advisor may use an annuity to address a specific financial goal, such as funding long-term care needs or supporting a surviving spouse. The predictable structure of annuities can simplify retirement planning and serve as a hedge against sequence-of-returns risk, which is the danger of poor market performance in early retirement years affecting long-term sustainability.
Potential Incentives and Conflicts of Interest
Annuities are often sold through arrangements that include built-in compensation for the advisor or insurance agent. The issuing insurance company often pays these commissions, which vary based on the type of annuity. Products like variable and indexed annuities tend to offer higher payouts, sometimes upfront and sometimes through ongoing trails tied to the contract’s value.
Because compensation is tied to the product, advisors may have financial incentives to recommend one annuity over another—or to recommend an annuity over a different kind of investment entirely. In some cases, incentives may also include bonuses, trips or access to preferred tiers with product providers. This can add complexity to the relationship and influence the presentation of options.
How to Tell If an Advisor Has Your Best Interests in Mind
Not all financial advisors are held to the same professional standard, and that can affect the advice clients receive—especially when it comes to products like annuities. Understanding how different standards apply can help clarify an advisor’s obligations and potential incentives.
Fiduciary advisors, such as registered investment advisors (RIAs), are legally required to act in a client’s best interest at all times. This means they must base their recommendations solely on the client’s needs, without regard to the compensation they may receive. Fiduciaries must provide full disclosure of any conflicts of interest and offer advice with loyalty and care.
Other advisors—such as insurance agents or broker-dealer representatives—may operate under a different framework. These professionals are typically subject to suitability or best interest standards, depending on the product and regulatory body. In the context of annuity sales, many follow rules outlined by the National Association of Insurance Commissioners (NAIC).
Under the NAIC’s revised Suitability in Annuity Transactions Model Regulation1, agents and insurers must act in the consumer’s best interest when recommending an annuity. This means they must consider the consumer’s financial situation, insurance needs and objectives—and the product recommended must effectively address those factors. While this “best interest” standard requires that the recommendation not place the producer’s interest ahead of the consumer’s, it does not prohibit commissions or require the same level of ongoing duty as a fiduciary standard.
Advisors operating under the NAIC’s framework must also disclose the nature of their relationship, the role they are playing in the transaction and whether they receiving compensation through commissions. However, the best interest obligation generally applies only at the time of the recommendation, not on an ongoing basis.
Asking Questions
Because of these distinctions in an advisor’s obligations, it can be helpful for clients to ask direct questions:
- Are you acting as a fiduciary in this relationship?
- How are you compensated for recommending this annuity?
- Why did you choose this product, and did you consider any alternatives?
An advisor’s answers to these questions can provide transparency around their role and help determine whether the recommendation is aligned with the client’s financial goals.
When an Annuity Might Make Sense
Annuities often make sense for individuals who need to cover fixed expenses and want guaranteed income regardless of market conditions. For example, a retiree with modest savings and no pension may benefit from using a portion of their assets to purchase a fixed or immediate annuity. This can create a stable income floor, making it easier to invest the rest of the portfolio more flexibly.
As another example, annuities can also appeal to individuals in good health who are likely to live a long time. This is because lifetime income annuities may deliver more value the longer someone lives.
Some annuities also offer inflation-adjusted payouts, which can help address rising costs over time. When tailored to the right circumstances, an annuity can provide predictable outcomes within a broader retirement strategy.
Alternatives to Annuities
For those looking to generate retirement income without using annuities, there are several other options worth considering. These alternatives offer varying degrees of flexibility, liquidity and risk:
- Dividend-paying stocks: This category of stocks provides ongoing income and potential capital appreciation but come with market volatility.
- Bond ladders: A bond ladder creates a predictable income stream by staggering bond maturities, reducing interest rate risk over time.
- Municipal bonds: This type of bond offers tax-advantaged income, especially attractive to investors in higher tax brackets.
- Systematic withdrawals: Making systematic withdrawals involves drawing income from a diversified investment portfolio. Though this allows for more control, it lacks guarantees.
- Delayed Social Security: Waiting to claim benefits can increase monthly payouts, offering a form of inflation-protected income.
- Deferred-income annuities (later in life): Although still a type of annuity, these often have a different use case. They are typically purchased later in retirement to cover expenses in advanced age, sometimes referred to as “longevity insurance.”
Bottom Line
Some annuities are sold, others are genuinely recommended—and many fall somewhere in between. The challenge for investors is not only understanding how annuities work but also recognizing the different motivations that may shape an advisor’s recommendation. When approached thoughtfully, annuities can play a meaningful role in retirement planning. But like any financial decision, they’re best considered in context, with a clear view of how they fit into broader goals and what trade-offs they might involve.
Retirement Planning Tips
- A financial advisor can help evaluate your retirement plan to determine whether you have enough saved and recommend strategies to grow your nest egg. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Mandatory distributions from a tax-deferred retirement account can complicate your post-retirement tax planning. Use SmartAsset’s RMD calculator to see how much your required minimum distributions will be.
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