If you ask ten financial advisers to explain annuity contracts, you might get ten different answers. That’s because there are countless types, features, and payout options, and each works a little differently.
At their core, an insurance annuity is a contract between you and an insurance company. You pay the company, either in a lump sum or over time and, in return, they promise to make payments to you. These payments may begin immediately or at a future date and can continue for a period as long as your lifetime. Depending on the terms of the annuity, the insurance company may provide contractual guarantees based on its claims-paying ability and payout rates. Additionally, available options at the time of purchase may be influenced by interest rates and market factors.
We believe annuities are not a financial plan in themselves, but rather products that can be used within a structured plan to minimize a specific, identified risk. Annuities should be evaluated for their “risk transfer” potential. If an investor can transfer a defined risk in exchange for a fair return, it is generally considered a good trade.
Before engaging in any investment product, you should understand: The initial and ongoing fee structure; any additional costs for extra guarantees; investment restrictions, including whether adding guarantees will reduce your investment options, and when and how you can access your funds, along with any penalties for doing so.
Recently, we spoke with an investor whose parents were being advised to purchase an annuity to help lower their required minimum distributions (RMDs). While we don’t know the specifics of their situation, we suspect they were being recommended a Qualified Longevity Annuity Contract (QLAC).
A QLAC is a type of deferred income annuity purchased today to generate a future income stream. The IRS allows deferred annuities meeting certain requirements to be purchased within a retirement account, with the deposit excluded from the IRA or 401(k) balance for RMD calculations. As of 2025, the limit is $210,000, applied across all of a person’s retirement accounts. This lifetime limit is indexed for inflation. Each spouse with their own retirement accounts can allocate up to $210,000 to a QLAC, meaning a married couple could potentially allocate $420,000.
Let’s say the investor defers annuity payments until age 85, when the income will be taxed at ordinary income tax rates. However, if an investor has a million-dollar IRA, sheltering $210,000 will likely have little impact on their RMD. The primary benefit of a QLAC is to protect against the possibility of outliving your retirement funds. For investors with limited retirement savings, deferred lifetime payments could provide income after their IRA is depleted, effectively transferring the risk of outliving their money to the insurance company.
There are many other considerations, including the claims-paying ability of the insurance company, future market conditions, inflation, the opportunity cost of removing $210,000 from market investments, the likelihood of living long enough to benefit beyond the original investment, as well as fees, surrender charges, complexity, and reduced liquidity compared to other investments.
Annuities can be valuable tools, but they’re not magic bullets. Before purchasing any product that claims to be a cure-all, consult a financial adviser who is not selling the annuity to ensure it truly fits your needs.
If you have questions on how an annuity might fit into your overall financial plan, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the August 9, 2022 “Henssler Money Talks” episode.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
