Should I Buy An Annuity?

By Financial Advisor Carrie McDonnell

Annuity sales are up in a big way. Limra, an insurance research group, reported record-level sales for 2023 with roughly a 23% increase from the record set in 2022. Marketed as a “safe” investment with a guaranteed stream of income, annuities are undoubtedly increasing in popularity due to investor concerns about the US economy. However, what investors may not know is that annuities carry risks of their own and that their decision to purchase a product like an annuity may be driven more by human bias than data and reason.

What are the risks associated with annuities?

Annuities tend to be highly complex insurance products that are very difficult to understand. As Tara Bernard of the New York Times aptly wrote, “Even a well-caffeinated person with an advanced degree in math would have a hard time deciphering a 53-page contract called ‘Your Flexible Premium Indexed and Declared Interest Deferred Annuity Policy.’” It makes you wonder if that level of complexity is necessary or a purposeful strategy when it comes to selling annuities.¹ Confusion and lack of understanding undoubtedly leads us to poor decision making. Not all annuity salespeople are purposefully taking advantage of clients, but there are many examples where that’s exactly what is happening. As a former educator, I know teachers are a common target group (An Annuity for the Teacher - And the Broker). In short, one risk to annuities is that when you sign a contract, you very likely won’t know what exactly you are signing off on.

Annuities are also known for having high fees and often have lower rates of return. Annuity fees come in the form of administration fees, maintenance fees and commissions paid to the advisor and/or insurance rep who sells you the annuity. Due to the complex nature of annuities, you may find it difficult to identify exactly what fees you paying. Additionally, one of the trade offs for guaranteed income is often lower annual rates of return. For example, The Annuity Experts’ report on “Best Fixed Annuity Rates for April 2024,” shows the highest fixed annuity interest rates range from 4.9 to 6.3% – a return range much lower than average returns associated with a low fee, diversified equity index strategy.²

Annuities lack liquidity and almost always involve a surrender period of years. During this period, the investor cannot withdraw funds without incurring a penalty fee, which can be substantial. Having funds locked up in illiquid investments can result in significant loss of financial opportunity.

Why do so many people buy annuities?

The study of behavioral finance provides important insight on how human emotions and biases impact our financial decisions with regard to annuities and other investments. Specifically, humans have a powerful aversion to loss and are hard wired to detect risk. While this cognitive tool makes sense when it comes to survival, in the modern context of investing, it can result in poor financial decisions, a condition known as “risk aversion bias.”³ Annuities, despite their often lower returns, lack of liquidity, and complex nature, appeal to our preference for predictability.

Working to keep our fear of loss in check is an important part of being a successful investor. Understanding risk aversion bias and developing self-awareness of our own behavioral bias, as well as seeking guidance from a fiduciary financial advisor, can put us in a better position for success. As writer and investor Robert Arnott put it, “In investing, what is comfortable is rarely profitable."

1. Nytimes.com, “Even Math Teachers Are at a Loss to Understand Annuities” Oct 28, 2016.
2. Annuityexpertadvise.com, April 2024.
3. Cnbc.com, “The Fear of Less Can Cost Investors Big-time. Here’s How” Nov. 29, 2022.