5 Reasons Not to Buy an Annuity, and One Exception

Most Criticism of Annuities Is Fair, But It Doesn’t Apply to All of Them

Ask most financial advisors about annuities and the same five objections come up. You lose liquidity. There is no flexibility. The fees are high. They are a poor investment. And they cannot keep up with inflation.

For the large majority of annuity contracts sold today, all five objections hold up. The products they describe really do lock money away, really do carry meaningful fees, and really do pay a flat income that erodes over a thirty year retirement.

What the objections tend to miss is that “annuity” is a category, not a product. There are five broad types on the market, each built for a different purpose, and one of them was specifically engineered around the five complaints listed above. It is also the type that affluent retirees, the ones who could self-fund their retirement without any guarantee at all, use to stretch a portion of their money further than the market can.

Here is where each objection actually lands, and what the exception looks like.

The 5 Reasons Advisors Say Not to Buy an Annuity

Advisors typically raise five concerns: no liquidity, no flexibility, high fees, poor investment returns, and no protection against inflation. Each objection is valid, and each one applies to a specific annuity type rather than to the category as a whole.

Reasons 1, 2 and 3: No Liquidity, No Flexibility, No Inflation Protection

These three objections belong to the two oldest products on the market: SPIAs (Single Premium Immediate Annuities) and DIAs (Deferred Income Annuities), which are only two of the five types of annuities available today.

With a SPIA or a DIA, the money is genuinely locked up for life. The contract is irrevocable, which means the owner cannot change course and cash out. Not in year three, not in year twenty. That is not a scare tactic, it is simply how the product was designed.

The inflation problem follows from the same design. Most buyers take these contracts with no inflation protection, and there is a practical reason for that. Adding an inflation rider to a SPIA or DIA typically reduces the starting income by roughly 30% to 50%. Faced with that tradeoff, most people accept the higher flat payment and the erosion that comes with it.

So when an advisor says annuities do not keep up with inflation, the statement is an accurate description of these two products.

Reason 4: Annuities Are a Poor Investment

This objection points at a different family of contracts: deferred annuities.

Fixed deferred annuities usually carry no explicit fees, but their growth is not going to be meaningfully better than a CD or a bond. They were never designed to be. The purpose is principal protection with a modest edge over other safe money, which is a reasonable goal rather than an exciting one.

Chasing real growth inside an annuity means moving to a variable annuity or a RILA (Registered Index-Linked Annuity), and that is where the costs appear. Between mortality and expense charges, subaccount fees, and riders, total annual costs of 2% to 4% are common. Over time those fees consume a significant share of whatever gains the contract produces.

On this point the critics are on solid ground. Most annuities make poor investments. The buyer either pays high fees that erode returns, or holds a conservative product that was never meant to compete with equities.

Why Certain Annuities Still Have a Place

Telling a retiree to avoid annuities because of surrender charges and fees is a little like telling someone not to buy a car because cars get poor gas mileage. Which car? A minivan? A sports car? A hybrid?

The criticism is accurate about the products it describes. What it leaves out is that those drawbacks belong to specific annuity types, and there is one type that rarely enters the conversation at all.

What Is a Hybrid Pension?

A Hybrid Pension is a fixed indexed annuity paired with a guaranteed lifetime income rider. It combines features from several annuity types into a single contract, providing principal protection, a contractually guaranteed lifetime income, penalty-free access to a portion of the account each year, and full liquidity once the surrender period ends.

Annuities evolved the way phones and televisions did. Beginning in the early 2000s, insurance carriers started combining the strengths of the older contracts while engineering out the drawbacks. The result is what KCIIS and other retirement specialists call a Hybrid Pension.

The label is not an attempt to disguise the fact that it is an annuity. It works the same way “smart TV” and “smartphone” work: the modifier tells you which generation of the product is under discussion. Without it, the conversation collapses back into arguing about a category that contains five very different things.

How a Hybrid Pension Handles Liquidity and Flexibility

Liquidity means being able to reach the money, ideally without a penalty. A Hybrid Pension has two distinct components, and each offers more access than the standard criticism suggests: the cash value and the guaranteed income rider.

The income side

The owner is never required to commit up front to a start date. Income can begin immediately or be deferred for years, and there is no penalty for turning it on at any point.

What early income costs is size. Payout rates are driven by age and by the length of the deferral, so the longer the wait, the larger the guaranteed payment becomes. The following illustration shows the general pattern:

What Vanguard’s Report Misses

Vanguard’s own examples cite annuity payouts around 6% to 8%, and their best example, 8.54%, applies to a single 75-year-old. As we’ve covered elsewhere, that’s because the report only discusses SPIAs and DIAs, annuities that lock up your principal permanently with no flexibility.

These figures are illustrative only. Actual payout rates depend on age, state of residence, the issuing carrier, and the rates in effect on the day the contract is signed. Once a contract is issued, however, the payout schedule is locked and cannot be changed by the insurance company.

A clarification on those numbers

A 20% figure understandably invites skepticism, so the distinction matters.

These are payout rates, not rates of return. They function the way Social Security and traditional pension benefits function: actuarial calculations based on current age, length of deferral, and life expectancy. Nothing in the contract promises 20% growth. What it promises is how much income will be paid each year for as long as the owner lives. The arithmetic behind those figures is covered in more detail in this breakdown of double-digit annuity payouts.

The reason the payments can be guaranteed in writing at all is that they come from an insurance carrier. Investment returns and interest rates cannot be guaranteed. Insurance obligations, backed by the claims paying ability of the issuer, can.

The cash value side

The next objection is usually surrender charges, which typically run 8 to 10 years.

Two details tend to be left out. During the surrender period, most contracts allow penalty-free withdrawals of 5% to 10% of the account value annually, and the surrender charge itself generally steps down each year rather than holding flat. After the surrender period ends, the contract has full liquidity. No penalty at all. The owner can cancel, take the entire balance, or move it elsewhere.

Context helps here too. A 401(k) or IRA carries a 10% early withdrawal penalty until age 59 and a half, which for someone who opened a retirement account in their twenties amounts to a penalty window of thirty years or more. That restriction rarely gets raised as a reason to avoid funding one.

What a Hybrid Pension Costs

Some contracts marketed as Hybrid Pensions do carry 2% to 4% in annual fees. Those are generally variable annuities and RILAs with an income rider layered on top.

Fixed Hybrid Pensions typically charge around 1% or less, and that fee purchases one specific thing: the contractual guarantee on the income stream. For comparison, 1% is roughly the standard fee to have a portfolio managed with no guarantee attached. These contracts carry no additional hidden fees, and agent commissions are paid by the insurance carrier rather than deducted from the client’s premium, the same arrangement used in auto and home insurance.

One feature of that fee is widely misunderstood. In a traditional investment, fees reduce what can be withdrawn. In a Hybrid Pension, the rider fee never reduces the guaranteed income. If the owner lives long enough to exhaust the cash value, the carrier does not bill for the difference. The fee simply stops, and the monthly payments continue for life.

That single provision is what separates the structure from every other annuity on the list, and it is the reason the word “pension” appears in the name at all.

Why Wealthy Retirees Buy Hybrid Pensions

In retirement the central question quietly changes. It stops being how much the portfolio can grow and becomes how much can be spent without running out.

That shift is where the leverage argument lives, and it explains why clients who could comfortably self-fund still move a portion of their assets into these contracts.

Consider $1 million. Growing it to $2 million over a decade sounds like a triumph, but under the 4% rule the spendable income is $80,000 a year. And that is the favorable scenario. If the same $1 million reaches only $1.5 million, the safe withdrawal falls to $60,000.

Run that same $1 million through a Hybrid Pension with a deferral of 5 to 10 years and, depending on age and prevailing rates, the guaranteed income could land somewhere between $100,000 and $200,000 a year. No projection required.

[IMAGE: Side by side comparison, 4% rule withdrawal vs. deferred Hybrid Pension payout]

At higher asset levels the same math scales. A household spending $500,000 to $1 million annually would need roughly $12.5 million to $25 million invested to sustain that under the 4% rule. At a 15% payout rate, comparable income could be generated from roughly $3 million to $6 million, leaving the remainder free for other purposes.

That remainder is the second and less obvious form of leverage. Once baseline living expenses are contractually covered for life, the rest of the portfolio no longer carries the burden of funding the lifestyle. It can be invested far more aggressively, or spent, or left to heirs. The same logic applies at $500,000 as at $25 million. Only the scale changes.

Why an insurance company can promise this

The structure sounds implausible enough that clients have asked, in so many words, whether it is a Ponzi scheme. That question is addressed directly in this piece on whether Hybrid Pensions are a scam, but the short answer is a matter of how insurance pricing works.

A $1 million life insurance policy pays the full death benefit even if the insured made a single premium payment and died the following month. Nobody considers that a scam, because it is an insurance contract priced on actuarial tables. The premium depends on age, and the older the applicant, the higher the cost.

A Hybrid Pension runs the same machinery in the opposite direction. The client pays a single premium, and the carrier pays out based on age and deferral. The older the buyer, the larger the payout.

Hybrid Pensions and Inflation

A Hybrid Pension on its own does not beat inflation, and no honest presentation should claim otherwise. The contracts with the highest payouts pay a flat income that never rises. Versions that include an inflation rider reduce the starting payout so sharply that the tradeoff is rarely worth taking.

That said, it is worth asking what actually does guarantee an inflation hedge. Stocks do not. Index funds do not. The 1970s produced a lost decade for equities, and the 2000s produced another. Safe money had its own version, with interest rates sitting between 0% and 1% from roughly 2010 to 2022. No asset class guarantees a real return. What retirees actually rely on is a strategy.

Ladder Out, then Ladder In

The approach KCIIS uses has two phases.

Ladder Out comes first. A larger initial deposit is structured to cover more than the target lifestyle, with headroom built in for rising costs across the first decade or so of retirement.

Ladder In follows. Smaller Hybrid Pensions are added later, funded with money that was not going to be touched anyway, often the dollars that would otherwise sit in CDs or bonds. Because the Ladder Out phase already covers the early years, each of these later contracts can be deferred 10 years or more.

That is where age and deferral compound. Each new contract is purchased at an older age, and each one is turned on at an older age still, which can push those later payouts into the 20% to 30% range, again depending on age, carrier, and rates at the time of purchase.

The practical effect resembles a series of raises. During working years, raises keep pace with the cost of living. Laddering In reproduces that pattern in retirement: every few years another income stream switches on, and because deferral increases the payout, each one pays more than the last. The mechanics are covered in full in this inflation strategy article.

The point is narrower than it first appears. When advisors say annuities cannot beat inflation, they are describing single flat contracts, not a laddered structure.

Should You Buy an Annuity?

The fair answer splits in two.

As an investment, a Hybrid Pension is unremarkable. The cash value will rarely outperform the market, and anyone presenting it as a growth vehicle is overselling it.

As an income vehicle, the comparison changes considerably. No safe withdrawal strategy gets far past 4% to 5% a year. Even the guardrails approach tops out near 5.7%, and it only functions if spending is cut during downturns, which pulls the effective average back down. Market growth is a projection. A contractual payout is an obligation.

The five objections are real. They are simply aimed at the wrong products.

Getting Specific Numbers

Firms that specialize in this area take a holistic view that includes taxes. The KCIIS approach, which the firm calls staging and laddering, divides assets into buckets to maximize the payout while managing what lands in each tax bracket.

Comparable planning through a fee based planner would typically cost $2,500 to $5,000. KCIIS does not charge for consultations. Because the firm does not sell stocks or bonds, its work stays concentrated on the annuity market, currently representing more than 50 plans across all 50 states, with 21 years of experience and more than $200 million in protected retirement income.

Payout figures cannot be quoted generically. Age, state, and current carrier rates all factor in, which means the only way to know a real number is to have it run. A consultation will do that.

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