Investing / The Compound Effect
Why We Rarely Recommend Annuities (And You Probably Shouldn't Own One)
| 5 min | By Heath J. Harris
Annuities are pitched as guaranteed income, but they're often more confusing than helpful -- and way better for the person selling them than the person buying them.
Let us talk about annuities -- the financial product that just will not die. They are pitched as "guaranteed income," "market protection," or "the smart way to retire." The brochures are polished. The language sounds secure. And the person explaining it to you always seems really confident -- and really motivated to close the deal.
But here is the truth: most annuities are more confusing than helpful -- and significantly better for the person selling them than the person buying them. They are, in many ways, the timeshare of retirement planning products: loaded with fine print, full of promises, and very hard to unwind once you are in.
At Compound Advisory, we are a fee-only fiduciary -- which means we do not sell products and we do not earn commissions. So when we say we rarely recommend annuities, it is not because we have a competing product to push. It is because, for the vast majority of our clients, there are better strategies available.
First: Follow the Money
When a traditional advisor or insurance agent sells you an annuity, they typically earn a 5 to 7 percent commission upfront. So if you roll $500,000 into an annuity, the person across the table gets a $25,000 to $35,000 payday -- right away. That commission is often hidden inside the contract, baked into the fees you will pay over the life of the product.
Compare that to a fiduciary advisor like Compound Advisory, who manages your money with transparent, ongoing fees and no product kickbacks. One model is built to serve your goals. The other is built to move product. When you understand the incentive structure, it becomes much easier to understand why annuities are so aggressively marketed to retirees.
The Lock-Up Period: Your Money, Their Rules
Most annuities come with a surrender period -- a lock-up of 6 to 10 years during which you cannot access your money without paying substantial penalties. Those penalties typically range from 7 to 10 percent of the withdrawal amount. So if you put in $500,000 and need $100,000 for a family emergency in year three, you could pay a $7,000 to $10,000 penalty just to access your own funds.
For retirees, this lack of flexibility is particularly concerning. Life in retirement is unpredictable -- healthcare needs change, family situations evolve, and opportunities arise. Locking up a significant portion of your assets in a product you cannot easily access runs counter to the kind of flexible, adaptive retirement income planning that actually serves people well over a 25- or 30-year retirement.
The "Guaranteed Income" Illusion
The phrase "guaranteed income" sounds reassuring. But it is worth examining what it actually means in most annuity contracts. In many cases, the "guaranteed income" is simply your own money being slowly returned to you -- with heavy fees, strict terms, and almost no real growth. The insurance company is not generating a magical income stream from nothing. They are investing your money, taking their cut (often 2 to 3 percent annually in total costs), and paying you back a portion over time.
After accounting for all fees, many annuity holders end up with effective returns lower than what a basic, diversified portfolio could have delivered over the same period -- without any of the restrictions, surrender charges, or complexity.
The Hidden Tax Problem
There is another issue that rarely gets discussed during the sales pitch: tax treatment. When you withdraw income from a non-qualified annuity, the growth portion is taxed as ordinary income -- not at the lower capital gains rate. For retirees in higher tax brackets, this can mean paying significantly more in taxes than they would with a well-structured investment portfolio that generates qualified dividends and long-term capital gains.
Additionally, annuities do not receive a stepped-up cost basis at death. When your heirs inherit an annuity, they may owe income tax on all of the deferred gains. Compare that to a taxable investment account, where heirs typically receive a stepped-up basis and can potentially inherit the assets with little or no income tax owed.
What We Recommend Instead
At Compound Advisory, here is what we help clients build instead of relying on annuity products:
- A diversified, properly allocated portfolio -- including dividend-paying stocks, bonds, and low-cost funds with global diversification, designed for your specific income needs and risk tolerance
- Dynamic withdrawal plans -- tailored to your actual life, pulling from the strongest-performing assets and harvesting strategically across account types to minimize taxes
- A cash reserve of 12 to 36 months -- providing breathing room when markets decline, so your long-term investments can keep compounding without being forced into premature sales
- Tax-efficient income layering -- coordinating Social Security timing, Roth conversions, and withdrawal sequencing to create a reliable income stream with the lowest possible tax burden
This approach provides flexibility, tax efficiency, and the potential for real growth -- none of which you get locked inside a typical annuity contract.
When an Annuity Might Make Sense
We are not saying annuities are universally bad. There are narrow situations where a low-cost, no-commission annuity -- used as one tool within a broader plan -- can serve a purpose. If you have no pension, are deeply concerned about longevity risk, and have already maximized every other income option, a simple single premium immediate annuity (SPIA) might provide a baseline of guaranteed income that adds peace of mind. But even then, it should represent a small portion of your overall strategy -- not the centerpiece.
The Bottom Line
At Compound Advisory, based in Annapolis, Maryland and serving clients virtually across the country, we do not sell products. We design strategies. We do not earn commissions. We earn trust. So before you lock up hundreds of thousands of dollars in something you do not fully understand, consider talking to a wealth management team that gets paid to protect your future -- not to sell you a contract. Our complimentary Retirement Clarity Assessment is designed to help you evaluate whether your current strategy is truly serving your best interests, or whether there is a better path forward.