As someone who’s been in financial services for over 20 years, I’ve seen retirement planning evolve dramatically. Back when I started my career at Northwestern Mutual in 2002, the conversation around retirement income was much simpler. Today, with traditional pension plans largely extinct and Social Security facing uncertainty, ordinary annuities have become an increasingly important piece of the retirement puzzle.
An ordinary annuity is essentially a contract with an insurance company where you contribute premium payments over time, and in return, receive guaranteed income payments that begin at the end of each payment period during your retirement years. Think of it as creating your own personal pension plan – something many of my clients find appealing when they realize their 401(k) alone may not provide the steady income they’ll need in retirement.
How Ordinary Annuities Work
The mechanics of an ordinary annuity are straightforward, which is part of their appeal. You make premium payments to an insurance company during what’s called the accumulation phase. These payments can be made monthly, quarterly, or annually, depending on your contract terms and financial situation.
During this accumulation phase, your contributions grow based on the terms of your specific annuity contract. The growth might be tied to a fixed interest rate, market indices, or other crediting methods, depending on the type of annuity you choose. What distinguishes an ordinary annuity is that any income payments you receive begin at the end of each payment period, not at the beginning.
Here’s what makes this timing distinction important:
• End-of-period payments allow for maximum accumulation time before each distribution • Compounding occurs throughout the entire period before payments begin • Planning becomes more predictable when you know exactly when payments will arrive
After working with hundreds of clients over the years, I’ve learned that this predictability is often what draws people to ordinary annuities. When you’ve spent decades watching your 401(k) balance fluctuate with every market swing, the idea of contractual guarantees becomes very attractive.
Types of Ordinary Annuities
Not all ordinary annuities are created equal. Understanding the different types can help you determine which might be most appropriate for your situation.
Fixed ordinary annuities provide the most predictability. Your premium payments grow at a guaranteed interest rate, and your future income payments are known from the start. While the growth rates might seem modest compared to market returns during bull markets, they provide certainty that many people value, especially as they approach retirement age.
Variable ordinary annuities tie your accumulation to investment subaccounts, similar to mutual funds. This means your future income potential could be higher, but it also introduces market risk. Your income payments will vary based on the performance of the underlying investments you select.
Indexed ordinary annuities attempt to bridge the gap between fixed and variable options. They credit interest based on the performance of market indices like the S&P 500, but typically include floors that protect against market losses and caps that limit upside potential.
In my experience, the choice between these types often comes down to your risk tolerance and where you are in your financial journey. Clients closer to retirement often gravitate toward fixed options for their predictability, while younger clients sometimes prefer indexed or variable options for their growth potential.
Benefits of Ordinary Annuities
The primary benefit I hear clients mention is the peace of mind that comes with guaranteed income. After spending years in a high-volume life insurance call center early in my career, having thousands of conversations with people about their financial concerns, I learned that most people’s biggest fear isn’t market volatility – it’s running out of money in retirement.
Ordinary annuities address this fear directly through several key benefits:
Contractual guarantees mean you know exactly what income you can count on, regardless of market conditions. This certainty allows for better retirement budgeting and planning.
Tax-deferred growth during the accumulation phase means you don’t pay taxes on growth until you receive income payments. This can be particularly valuable if you expect to be in a lower tax bracket during retirement.
Professional management removes the burden of making ongoing decisions about your retirement funds. Once your annuity is in place, the insurance company handles the administrative aspects.
Longevity protection ensures that if you live longer than expected, your income continues. This is something traditional retirement accounts can’t guarantee – they can be depleted.
What surprises many people is that annuities can also provide flexibility. While they’re designed for long-term accumulation and income, most contracts include provisions for accessing funds in emergencies, though this typically involves surrender charges during the early years.
Potential Drawbacks to Consider
Honesty has always been central to how I work with clients, and that means discussing limitations alongside benefits. Ordinary annuities aren’t perfect solutions for everyone, and understanding their drawbacks is crucial for making informed decisions.
Limited liquidity is probably the most significant concern. Unlike a savings account or even most retirement accounts, annuities typically impose surrender charges if you need to access large amounts during the early years of your contract. These charges can last anywhere from five to ten years or more.
Fees and costs can impact your accumulation over time. Annual fees, management charges, and rider costs can add up. While these costs are disclosed in your contract, they’re important to understand upfront.
Inflation risk is real with fixed annuities. An income payment that seems adequate today might feel insufficient twenty years from now if inflation erodes its purchasing power.
Opportunity cost means that money committed to an annuity can’t be used for other potentially higher-returning strategies. During strong market periods, you might feel like you’re missing out on gains.
I always encourage potential clients to view annuities as one component of a diversified retirement strategy, not a complete solution. The question isn’t whether annuities are good or bad – it’s whether they serve a specific purpose in your overall plan.
Who Should Consider Ordinary Annuities
After more than a decade as an independent agent, I’ve noticed certain patterns in who tends to benefit most from ordinary annuities. While every situation is unique, there are common characteristics among clients who find them most valuable.
Pre-retirees without pensions often find annuities appealing because they recreate the steady income stream that previous generations received from employer pension plans. If your retirement plan relies primarily on 401(k) savings and Social Security, an annuity can provide that third leg of stability.
Conservative investors who prioritize capital preservation over growth potential often appreciate the guarantees that annuities provide. If the thought of market volatility keeps you awake at night, the contractual nature of annuity benefits might provide valuable peace of mind.
People with longevity concerns – either because of family history or personal health – sometimes use annuities as insurance against outliving their money. This is particularly relevant for women, who statistically live longer than men and need their retirement funds to last longer.
High earners looking for tax deferral beyond their 401(k) contribution limits sometimes find annuities useful. Since annuities don’t have annual contribution limits like IRAs and 401(k)s, they can provide additional tax-deferred accumulation space.
However, annuities typically aren’t ideal for everyone. Young investors with long time horizons might find the growth limitations restrictive. People who need maximum flexibility with their funds might find the liquidity constraints problematic.
Ordinary Annuity vs. Other Retirement Strategies
One conversation I have regularly with clients involves comparing annuities to other retirement planning approaches. Each strategy has its place, and understanding how they complement or compete with each other is important.
Annuities vs. 401(k) plans: Your 401(k) provides tax-deferred growth and potentially employer matching, but it doesn’t guarantee income. Annuities provide guaranteed income but typically don’t offer employer contributions. Many successful retirement plans include both.
Annuities vs. IRAs: Traditional and Roth IRAs offer tax advantages and investment flexibility, but they have contribution limits and required minimum distributions. Annuities don’t have contribution limits and can provide guaranteed income, but they typically have higher fees.
Annuities vs. other insurance strategies: This is where my experience with various life insurance products becomes relevant. Some clients discover that max-funded life insurance policies using strategies like the MPI approach can provide tax-advantaged accumulation and flexible access to funds, potentially offering more versatility than traditional annuities.
The key is understanding what each strategy does well and building a plan that addresses your specific needs. I’ve never met someone whose entire retirement plan should consist of just one approach.
Making the Decision
Choosing whether to include an ordinary annuity in your retirement plan requires honest assessment of your goals, risk tolerance, and overall financial situation. Here are the key questions I encourage people to consider:
What’s your primary concern? If it’s market volatility and you value guarantees above growth potential, annuities might be appealing. If it’s maximizing growth and you’re comfortable with market fluctuations, other strategies might be more appropriate.
How important is liquidity? If you anticipate needing access to large amounts of your retirement funds for emergencies or opportunities, the surrender charges associated with annuities might be problematic.
What’s your time horizon? Annuities typically work best when you have at least ten years before needing income, allowing time for accumulation and for surrender charges to expire.
How does this fit with your other retirement accounts? Annuities often work best as part of a diversified approach rather than as your sole retirement strategy.
I always recommend that people considering annuities work with someone who can show them multiple options and explain how different strategies might work in their specific situation. The right choice depends on factors that are unique to you.
If you’re exploring how ordinary annuities might fit into your retirement planning strategy, I’d be happy to discuss your specific situation. With over 20 years in financial services and experience helping hundreds of families plan for their futures, I can help you understand how different approaches might work for your goals. Contact Heritage Life Solutions today to schedule a consultation and explore whether ordinary annuities align with your retirement vision.
