Why Do People Buy Annuities?

Quick Answer: People buy annuities to supplement Social Security, secure a guaranteed lifetime income, grow money tax-deferred, protect assets from market losses, and guard against inflation — among other compelling reasons. Annuities come in many forms, and their contractual guarantees make them one of the most versatile retirement planning tools available.

If you are exploring ways to generate income in retirement, you may have thought about annuities at some point. Of course, annuities can be quite involved sometimes. They come in many flavors, and it's quite natural to ask why people buy annuities.

The reasons are different for everybody. But one short answer is because annuities can provide more financial peace of mind with their contractual guarantees, backed by the life insurance company.

Annuities have grown in popularity, as people can use them to supplement their Social Security payouts, have a guaranteed lifetime income stream, earn interest on their money, protect their assets against market losses, and enjoy tax-advantaged financial growth. Paying for long-term care, offsetting inflation, and shielding assets from probate and creditors are a few other reasons as well.

In this article, we will delve into reasons behind why people buy annuities and how these guaranteed financial vehicles can contribute to a well-rounded financial strategy.

Eight Reasons Why People Buy Annuities

Here are the major reasons why people buy annuities for their retirement planning strategy. Of course, they are just a few of many motivations for annuity contract ownership.

1. Supplementing Social Security

This is one of the biggest reasons why people own annuities, as many surveys report. While it provides a basis for retirement income, Social Security often falls short of covering all monthly living expenses. Retirees need additional sources of income to keep up their desired lifestyle, especially as life expectancy in retirement goes up.

Annuities bridge this income gap by offering a steady stream of payments that can complement Social Security benefits. This extra income not only helps cover monthly expenses for your lifestyle, but also provides peace of mind by providing you with ongoing, predictable income payouts each month.

2. Guaranteed Lifetime Income Stream

One of the most compelling reasons individuals purchase annuities is the promise of a guaranteed lifetime income. An annuity essentially works as a contract between someone and an insurance company.

In exchange for a lump-sum premium or a series of premium payments, the insurance company agrees to provide regular payouts for the rest of the individual's life. This predictable income stream is invaluable, as it ensures that retirees won't outlive their savings, regardless of equity market swings or economic downturns.

The guarantees depend on the insurance company's ability to stand behind them. That being said, life insurance companies have a solid track record of delivering on those promises in all sorts of economic conditions.

3. Tax Advantages

Annuities offer distinct tax advantages that make them an attractive option for retirement saving alongside retirement accounts. During the accumulation phase (or our working years), the earnings within an annuity are tax-deferred. This means that the money inside an annuity can grow without the immediate burden of income tax being due, allowing the money to compound more effectively over time.

When withdrawals begin, income tax is due on the withdrawn amount. However, the payouts from the annuity can also be spread out over the payout period. This tax-efficient strategy can help you plan for, and even manage, your tax burden in retirement.

4. Protection Against Market Losses

The stock market's volatility can cause great stress for retirees who depend on their investments for income. Annuities provide a solution by protecting crucial assets from market losses.

While growth potential of annuities might be lower than those of riskier investments, the trade-off is a sense of security that people have from knowing that their principal is protected. This aspect makes annuities an appealing option for risk-averse investors who prioritize stability over high returns.

5. Competitive Interest Rates

Bank CDs (certificates of deposit), savings accounts, and traditional interest-earning assets may offer lower interest rates than fixed-type annuities do, limiting the growth potential of one's savings. Annuities, on the other hand, have the potential to beat the bank and other low-interest vehicles, especially in a low interest rate environment.

Life insurance companies invest the annuity premiums into a variety of assets, which can include fixed income securities, equities, and real estate. For fixed-type annuities, most premium dollars go into low-risk investments. As a result, annuities can earn more competitive yield over the long term compared to other low-risk investments and instruments.

6. Resources for Long-Term Care

Long-term care costs can be a major concern for retirees. Annuities can address this concern through optional, add-on benefits that provide access to funds for long-term care needs.

Some annuities offer enhanced payouts if someone requires long-term care, helping relieve the financial strain associated with medical and caregiving expenses. This feature provides retirees with the peace of mind that they won't be forced to deplete their assets to cover unexpected healthcare costs.

7. Guard Against Inflation

Inflation eats away into the purchasing power of retirement income over time. Annuities offer options to counteract this effect by providing payouts that increase with inflation.

These inflation-adjusted annuities help assure that retirees can keep up their lifestyle even as the cost of living rises. In turn, annuity owners have financial resources with the annuity's lifetime payments to meet their financial needs throughout their retirement years.

8. Protection from Probate and Creditors

When someone passes away, the transfer of assets to heirs through the probate process can be time-consuming and expensive. However, annuities often bypass probate and pass directly to the designated beneficiaries, simplifying the estate settlement process.

Additionally, annuities can offer protection from creditors in certain situations. That can help loved ones receive their assets without the disruption of outstanding debts or legal claims. This protection varies by state, however.

The Bottom Line on Why People Buy Annuities

In times when economic conditions are uncertain, people want some measure of protection and stability in their financial plans. There is a lot of peace of mind that can come from having some strategies for financial stability and security in your overall retirement plan. Annuities are a versatile solution that can address many financial risks with their contractual guarantees.

Many people use annuities to supplement their Social Security and provide a guaranteed lifetime income for retirement. They can enjoy tax-advantaged growth for their money, protect assets against market losses, and have a guard against inflation. The ability to have financial resources for long-term care, shield assets from probate and creditors, and have solid interest-earning potential also increases the appeal of annuities.

However, remember that annuities come in various forms, each with its own set of features, benefits, and costs. Before committing to any annuity (or a financial product of any sort, for that matter) talk to your financial professional, have them explain it, and ask any questions on your mind. Make sure that they choose the type of annuity that aligns with your personal financial situation, goals, and risk tolerance.

Ultimately, the annuity needs to solve clear problems in your financial plan and be part of a well-rounded retirement strategy that is tailored to your unique picture. Talk to your financial professional about annuities today and how they can work for you.

If you are looking for a financial professional to help you sort out your retirement 'what-ifs' in general, you may want to look for someone independent. An independent agent or financial advisor has the ability to offer solutions from multiple insurance and financial companies — not just one parent company or a few companies — and has the business freedom to shop among all those options for you.

Frequently Asked Questions

Why do people buy annuities for retirement?

People buy annuities primarily to create income they cannot outlive. Social Security alone rarely covers all retirement expenses, and annuities bridge that gap with contractual, guaranteed payments. Other motivations include tax-deferred growth, protection from market volatility, and optional benefits that cover long-term care costs.

How does a guaranteed lifetime income annuity work?

In exchange for a lump-sum premium or a series of payments, an insurance company contractually agrees to pay you a fixed income for the rest of your life. The payments continue regardless of how long you live or what the stock market does. The strength of those guarantees depends on the financial strength of the issuing insurer — which is why insurance company ratings matter.

Do annuities really protect against market losses?

Fixed and fixed indexed annuities do not expose your principal to market risk. A fixed annuity credits a guaranteed interest rate; a fixed indexed annuity can earn interest linked to a market index while protecting you from losses when the index falls. Variable annuities are a different story — their value fluctuates with investment subaccounts and they carry full market risk.

What tax advantages do annuities offer compared to a brokerage account?

Inside an annuity, earnings grow tax-deferred — you pay no income tax each year on interest, dividends, or gains. Tax is owed only when you take withdrawals. This deferral lets your money compound on a larger base over time. When you receive annuity income, it can be spread over years, potentially keeping you in a lower tax bracket than taking a lump sum from a taxable account.

Can annuities pay for long-term care?

Many fixed annuities and fixed indexed annuities offer optional long-term care or confinement care riders. When you qualify (typically by being unable to perform a set number of activities of daily living), the annuity can double or even triple your income payout to help cover care costs. This approach is often more flexible than traditional long-term care insurance and doesn't require you to use it or lose it.

Ready to explore which type of annuity fits your retirement plan? Find a financial professional at SafeMoney.com — many independent advisors are available to discuss your situation at no cost.