Modern Annuities Explained: What Retirees Buy Now

Whenever someone tells me they hate annuities, I always ask the same question:

What kind of annuity?

Many people have strong opinions about annuities without ever reviewing a contract or learning how the different types work. The challenge is that every annuity shares the same general name, even though the fees, risks, growth methods, liquidity features, and income options can be very different.

The annuities of yesterday are not the same as many of the annuities available today.

In this Retirement Income School™ lesson, I’m breaking down how annuities have evolved, the differences between variable annuities, multi-year guaranteed annuities, and fixed index annuities, and how to determine which type may fit your retirement goals.

Not All Annuities Are the Same

Imagine encountering two dogs.

One is an aggressive stray that bites you. The other is a friendly Labrador puppy that wants to play. They are both dogs, but you would never describe or approach them in the same way.

Annuities are similar.

Products with very different features are often grouped into one category simply because they are all called annuities. This can lead retirees to dismiss every annuity based on a bad experience—or something they heard—about one particular type.

One of the most common objections I hear is that annuities have high fees. Some annuities do have multiple ongoing charges, but others may have no annual contract fee.

Understanding the specific contract is what matters.

How Annuities Have Evolved

The idea behind annuities dates back centuries. During the Roman Empire, citizens could make a payment in exchange for annual lifetime income. The Latin word annua referred to an annual payment or stipend.

In more recent history, traditional fixed annuities were popular when interest rates were high. An individual could give money to an insurance company and receive a fixed rate without being connected to the stock market.

These were relatively straightforward contracts.

As interest rates changed and consumers wanted additional growth potential, new types of annuities entered the marketplace. Variable annuities offered direct market participation, while fixed index annuities later provided interest-crediting opportunities linked to an external market index without directly investing the contract value in that index.

Modern annuities may also include liquidity provisions, beneficiary benefits, care-related waivers, and optional lifetime-income riders.

That evolution is important because many of the criticisms people associate with annuities are based on older designs or a different type of contract altogether.

What Is a MYGA?

A multi-year guaranteed annuity, commonly called a MYGA, provides a fixed interest rate for a specified period. The term may commonly range from approximately three to ten years, depending on the carrier and contract.

You can think of a MYGA as having some similarities to a certificate of deposit, although a MYGA is an insurance product rather than a bank product.

A MYGA may provide:

• A fixed interest rate for the contract term
• Tax-deferred accumulation
• Options for receiving interest or allowing it to compound
• A return of the contract value at the end of the term
• The ability to complete a tax-deferred exchange into another qualifying annuity

Rates, withdrawal provisions, surrender periods, and other features vary by carrier and contract.

A MYGA may be considered when someone wants a portion of their retirement assets positioned for predictable, tax-deferred growth without direct exposure to stock market losses.

Some contracts provide annual liquidity or interest withdrawals. Others may offer a higher rate in exchange for more limited access to the money. That is why it is important to compare more than the advertised interest rate.

What Is a Fixed Index Annuity?

A fixed index annuity, or FIA, is an insurance contract that credits interest based in part on the performance of an external index, such as the S&P 500.

Your contract value is not directly invested in the index.

Instead, the insurance company uses a crediting method that may include a cap, participation rate, spread, or other limitation. When the index performs positively, interest may be credited according to the contract’s terms. When the index declines, the contract’s floor can protect the account from losing value because of that market decline.

A fixed index annuity may offer:

• Protection from direct stock market losses
• Tax-deferred accumulation
• Index-linked interest-crediting potential
• Multiple allocation or crediting options
• Optional liquidity provisions
• Beneficiary benefits
• Optional lifetime-income features

A 0% floor does not mean the contract will earn interest every year. It generally means a negative index result will not create a negative interest credit because of market performance. Withdrawals, surrender charges, rider fees, and other contract provisions can still reduce the value.

Many fixed index annuities do not have an annual base contract fee. However, optional features, enhanced crediting strategies, bonuses, or income riders may carry charges.

Why Variable Annuities Have a Different Reputation

Variable annuities became popular with consumers who wanted greater market participation inside an annuity contract.

Unlike a MYGA or fixed index annuity, a variable annuity generally invests in market-based subaccounts. This creates more growth potential, but it also exposes the account value to market losses.

Variable annuity expenses may include:

• Mortality and expense charges
• Investment subaccount expenses
• Administrative or contract charges
• Optional rider fees
• Charges for lifetime-income or death-benefit features

The total cost depends on the contract and the options selected.

Variable annuities are not automatically good or bad. The real question is whether the benefits justify the costs and risks for the person purchasing the contract.

For retirees, market exposure and ongoing fees deserve careful consideration. Fees are generally charged whether the underlying investments rise or fall, and account values may fluctuate with market performance.

If you own a variable annuity, do not rely only on the return displayed prominently on the statement. Ask the carrier for a complete breakdown of the contract’s fees, current account value, cost basis, surrender value, rider value, and actual performance since purchase.

You need to understand what you are paying and what you are receiving in return.

Comparing the Three Types of Annuities

Each type of annuity is designed to perform a different job.

Variable annuity

• Offers direct market participation through investment subaccounts
• Can experience market gains and losses
• Commonly includes multiple ongoing expenses
• May appeal to someone seeking greater growth potential who can tolerate market risk

Multi-year guaranteed annuity

• Provides a fixed rate for a stated period
• Does not directly participate in the market
• Is generally designed for predictable accumulation
• May offer limited annual withdrawals depending on the contract

Fixed index annuity

• Credits interest according to an external index and contract formula
• Is not directly invested in the market
• Provides protection from market-index losses through a floor
• May be designed for accumulation or paired with an optional income rider

The right comparison is not simply which product offers the highest illustrated number. You also need to consider liquidity, surrender charges, taxes, fees, financial strength of the insurer, beneficiary provisions, and the role the money must serve within your overall retirement plan.

The Old Way: Annuitization

Historically, creating income from an annuity often meant annuitizing the contract.

Annuitization converts the contract value into a stream of payments. Depending on the option selected, that decision may be permanent. Under certain payout choices, the owner may give up access to the contract value, and little or nothing may remain for beneficiaries after an early death.

This is one reason some people believe that giving money to an annuity company means losing control of it.

That concern may have been valid for a particular contract or payout option, but it does not describe every modern annuity.

Today, some fixed index annuities offer optional lifetime-income riders that can create an income stream without requiring traditional annuitization.

How Modern Income Riders Work

A lifetime-income rider is an optional feature that can be added to certain annuities. It is designed to provide income for the life of one person or, when selected, the lives of two spouses.

The rider usually has an annual charge. In exchange, it establishes contractual rules for calculating future income.

Depending on the contract, an income rider may provide:

• Lifetime income for one or two people
• Continued access to the remaining contract value
• A death benefit for beneficiaries
• Annual withdrawal provisions
• Nursing-home, terminal-illness, or care-related waivers

These features vary significantly among carriers.

Taking excess withdrawals may reduce the contract value and future income. Waivers also have eligibility requirements and may not be available in every state or contract.

The value of the rider is not simply the amount shown on an illustration. You must understand how the income base works, when income can begin, what withdrawal percentage applies, how fees are assessed, and what happens after withdrawals start.

An Annuity Should Have a Specific Job

For most retirees, an annuity is not intended to beat the stock market.

It is intended to perform a particular job within the retirement plan.

That job may be to:

• Protect: Keep a portion of retirement savings away from direct market losses
• Grow: Provide fixed or index-linked interest-crediting potential
• Create income: Establish a predictable retirement paycheck that cannot be outlived, subject to the insurer’s claims-paying ability

These are different goals, and they may require different contracts.

An accumulation-focused FIA or MYGA is not the same as an annuity designed to produce lifetime income. Even two annuities within the same category can have different rates, terms, liquidity provisions, crediting methods, and surrender schedules.

Start by identifying the job before comparing the products.

Growth and Income Require Different Designs

One of the biggest misconceptions about annuities is that they are only used for income.

Some annuities are designed primarily for accumulation. Others are designed to produce income. Trying to use one contract for the wrong purpose can lead to disappointing results.

If your priority is protected accumulation, you may compare MYGAs and accumulation-focused fixed index annuities.

If your priority is guaranteed lifetime income, you may evaluate a fixed index annuity with an income rider or another income-focused annuity structure.

If your priority is market participation and you are comfortable with investment risk and higher expenses, you may consider whether a variable annuity fits that role.

The product should be selected only after your objective is clear.

Questions to Ask Before Purchasing an Annuity

Before moving money into an annuity, ask:

1. What specific job will this annuity perform in my retirement plan?
2. Is the contract designed primarily for accumulation or income?
3. What fees or rider charges will I pay?
4. How is interest calculated and credited?
5. How long is the surrender period?
6. How much money can I access each year?
7. What happens if I need additional funds?
8. How will withdrawals be taxed?
9. What will my beneficiaries receive?
10. What happens if the insurance company changes a cap or participation rate?
11. Is the proposed exchange or replacement in my best interest?
12. How does the insurer’s financial strength support its obligations?

Never make the decision based on one rate, bonus, or illustrated income number.

Review the complete contract and make sure the recommendation fits your income needs, liquidity requirements, time horizon, tax situation, risk tolerance, and broader financial plan.

The Right Question to Ask

The ultimate question is not:

Are annuities good or bad?

The better question is:

What job do I need this money to do, and is this annuity appropriately designed to do it?

Annuities can protect principal from direct market losses, provide tax-deferred accumulation, and create contractual lifetime income. However, they are not one-size-fits-all, and every benefit comes with terms, limitations, and tradeoffs.

The goal is to choose the right tool for the right purpose at the right stage of retirement.

What to Do Next

If you are considering a fixed indexed annuity, compare more than the illustrated interest potential.

Review the insurer, surrender period, liquidity provisions, caps, participation rates, rate guarantees, renewal provisions, optional rider fees, and minimum guaranteed values.

Most importantly, determine how the contract would fit into your complete retirement plan.

Want help exploring whether an FIA may be appropriate for your retirement goals? Visit Retirement Income School™ and click Book a Q&A Call.

DISCLAIMER:
The information in this lesson is provided for general educational purposes only and does not constitute financial, legal, or tax advice. Retirement Income School™ and Dr. Amanda Barrientez do not provide individual investment recommendations. Always consult with a licensed advisor or tax professional before implementing any strategy discussed.