When it comes to annuities, there’s often a significant gap between what people expect and what they actually deliver. Some dismiss them entirely due to concerns over high fees, while others are drawn in by flashy sales pitches promising unrealistic returns. Both perspectives miss the mark.
Annuities are straightforward financial contracts designed to provide specific guarantees, not magical solutions. Understanding their true function requires looking beyond the hype and focusing on what they can genuinely offer.
The Four Key Purposes of Annuities
Annuities serve a few specific purposes, and it’s crucial to understand these before considering one. I use the P.I.L.L. framework to explain the four main roles of annuities:
- Principal Protection
- Income for Life
- Legacy Planning
- Long-Term Care / Confinement Care
If your financial goals don’t align with any of these, then an annuity might not be the right tool for you.
Expectation #1: “Market Gains with No Risk”
One of the most popular claims made by sellers of Indexed Annuities is the promise of “market gains without any downside.” At first glance, this sounds ideal—participating in the stock market’s upside while keeping your principal safe.
Reality:
Unfortunately, it’s not as simple as it seems. Indexed Annuities typically offer returns between 2% and 4% annually over the long term. Some years might see higher returns, but these are often offset by years with little or no growth. You won’t experience steady, double-digit returns like some advertisements suggest.
If a product genuinely offered unlimited market growth with zero risk, major financial institutions would be all over it. The truth is, Indexed Annuities are designed to provide conservative, bond-like returns with principal protection—not equity-level growth.
Expectation #2: “Guaranteed Inflation Protection”
With inflation being a major concern for retirees, many annuity products are marketed as offering protection against rising costs. The idea is appealing, as it promises an income stream that keeps pace with inflation.
Reality:
No annuity directly tracks inflation—none. Some income annuities come with a Cost-of-Living Adjustment (COLA) rider, which increases payouts by a set percentage each year (typically 2% or 3%). But these adjustments come at a price. It often takes several years for the higher payouts to make up for the lower initial income compared to a level payout.
The only true inflation-adjusted annuity is Social Security, as its increases are based on political adjustments rather than actuarial calculations. Annuities can provide guaranteed income, but they won’t perfectly track inflation.
Expectation #3: “One Annuity to Solve All Your Problems”
Some salespeople promote annuities as a one-size-fits-all solution, claiming they can offer upfront bonuses, market growth, lifetime income, principal protection, and even long-term care benefits—all rolled into one.
Reality:
No single annuity can do it all. Just like there isn’t one medication that cures every ailment, no annuity will address every retirement need. If you’re seeking principal protection, look for a product designed for that. If you need lifetime income, select an annuity focused on income guarantees. Likewise, if you’re concerned about legacy planning or long-term care, these require separate consideration.
Trying to bundle all of these features into one product often leads to unmet expectations.
Why Sales Pitches Fall Short
The gap between expectations and reality often comes from how annuities are sold. Many sales presentations rely on hypothetical scenarios, backtested numbers, or promises of “too good to be true” outcomes.
But when the contract finally arrives, what you have is a clear and detailed agreement outlining exactly what the annuity will provide—and nothing more. If you were promised upfront bonuses, market-like growth, or “free” benefits, the reality check will hit once you read the terms.
There are no “free” lunch offers in the annuity world. Insurance companies aren’t in the business of giving away money—they’re in the business of guaranteeing payouts, and they’ve structured their products to protect their bottom line.
The Right Questions to Ask
To navigate through the noise, focus on two essential questions:
- What do you want the annuity to contractually provide?
- When do you want those guarantees to begin?
If your goal is market growth, then an annuity is probably not for you. But if you’re looking for guaranteed income, principal protection, legacy planning, or long-term care benefits, then an annuity might fit into your financial plan.
Final Thoughts: Aligning Expectations with Reality
The truth about annuities is straightforward: they’re tools designed for specific purposes, and they work best when used for what they’re contractually guaranteed to do.
Don’t get swayed by the hype or chase after products that promise everything at once. Focus on the guarantees, understand the contract, and ensure the product aligns with your unique financial situation.
When you set realistic expectations and match them to the right product, annuities can play a valuable role in your retirement planning, providing stability, security, and peace of mind where other investment options might fall short.
