Personal Finance

Baby Boomers Beware: How Annuities Can Lock You Into Poor Returns

David Beren

Published: February 22, 2025 12:07 pm

For any baby boomer looking to ensure they have enough money to live while retired, being sold an annuity feels like a dream come true. The idea that you can purchase guaranteed, lifelong income with either an upfront or monthly premium feels like the deal of the century. 

However, as with many things, annuities are great on paper until you read the fine print. Any member of the baby boomer generation who hasn’t read the fine print may find that the same fine print is causing them to lose more money than expected. 

What Is An Annuity? 

Before discussing how baby boomers should be aware of annuities, it’s essential to understand precisely what an annuity is. For this conversation, an annuity is a contract you agree to with a life insurance company that will provide you with guaranteed income. This income can be purchased upfront or through monthly payments (or “premiums”) over time. 

Three Types of Annuities 

As a baby boomer, you can choose three different annuity types as part of an annuity agreement. The first is a Fixed annuity, which requires monthly payments and grows at a predetermined rate set by the insurance company. As this amount is considered “fixed,” anyone choosing this annuity type knows precisely how much income they will receive regularly (monthly). 

A Variable annuity is invested in things like a mutual fund, and your earnings are not fixed. What makes a variable annuity attractive is that earnings can and will go up or down based on the mutual fund’s performance. There’s some risk involved, but the payoff can be higher over a fixed annuity. 

Lastly, an Equity Indexed mutual fund is in the middle of the two other types. This annuity is tied to the stock market’s performance, and if the market has a good year, you will receive some additional interest with your payments. However, you don’t receive anything extra if the market performs poorly. 

How the Market Affects Annuities

Moving past the “what” as far as annuities, it’s time to dive into some specific reasons baby boomers should beware. 

The Rising Market

When choosing an annuity, a fixed annuity is the most popular because it provides you with a guaranteed rate of return, and you always know the payment. However, this is precisely why a fixed annuity can also be detrimental as well. 

You’re out of luck if you’re invested in fixed annuities and the stock market goes on a bull run. In other words, because fixed annuities are not directly tied to market performance, you will miss out on any growth that would coincide with a bull market. 

Separately, there is also a concern with fixed annuities and inflation, as the dollar’s buying power won’t go as far as the years continue on. This is especially true during periods of high inflation when you have less buying power because everything you are earning is fixed. While you can purchase inflation-adjust or inflation-protected annuities, the downside is that you will still likely be capped on your returns. 

Capping Your Returns

Using the fixed annuity example once again is essential because it accounts for the largest percentage of sold annuities (as much as 40% of all annuities sold, according to LIMRA). Without it, you could be leaving significant money on the table. 

Of course, it’s not just fixed annuities that are subject to caps, as the same can be said about indexed annuities. While there is definite upside potential regarding earnings with an indexed annuity over a fixed annuity, there is still a cap. 

Let’s say, for example, that you have an indexed annuity with a cap of 4% growth, but the market is up 9%. You’ll lose out on that 5% growth. Over time, this missed percentage can equal thousands, if not tens, or hundreds of thousands in compounded losses. 

The bottom line is that boomers will likely earn significantly more during periods of strong market performance if they invest in stock market securities, a 401(k), or an annuity. 

Lengthy Term Concerns

Aside from capped returns, the other primary factor that could cause baby boomers to lose out on greater returns is surrender charges. Suppose you need to access money early from an annuity for medical expenses or to help a child. In that case, surrender charges will be very frustrating to baby boomers. 

A baby owner annuity “owner” must know these surrender charges could be substantial. In some cases, surrender charges could be as much as 7% of the annuity’s value in year 1, a not-so-insignificant amount of money. An annuity has some immediate downsides when you have to pay this alongside commission fees upfront in the first year. 

In other words, if you have $100,000 invested in an annuity and want to pull out $10,000 for any reason, you could pay close to $1,000 extra just because of any fine print surrender charges. While these charges go down over time, this is still a lengthy concern to consider, as the penalty could still be 3% in year 7. 

Strategies for Evaluating Annuities 

Upfront Strategy

The bottom line with an annuity is that you must read all the fine print, and having a financial advisor or lawyer read along with you is a good idea. First and foremost, you want to pay attention to the surrender charges, some of the most significant fees you can find with any annuity type early on in your life. 

In addition, you should compare multiple annuity products from different insurance agencies to compare terms. This is where a financial advisor comes into play. You should work with someone who isn’t affiliated with any company and listen to their advice, as they are likely more familiar with annuity types. 

Exit Strategies 

If you need to exit an annuity, it isn’t easy, but it isn’t impossible. The best idea is to look at the 1035 exchange concept, which allows individuals to transfer annuities from one person to another without any tax considerations. This enables you to avoid capital gains taxes on the original annuity contract, and you don’t have to cash out anything. 

While it’s a tall order, you can talk with the insurance company to see if they will be flexible on surrender charges. Your specific situation will determine the likelihood of success, but it’s not a complete impossibility to think that they might work with you (at least once) to help you out. 

Better Investment Options

Ultimately, baby boomers need to know that better investment options exist that eliminate the earnings cap you will find on annuities. For example, investing in stocks comes with significant upside during a bull market, but you have to be considerate of a bear market when you could risk all of your gains. To be in the stock market, you must have a certain amount of risk tolerance to be primarily invested, but the upside can be significant. 

Separately, looking at bonds will offer you more upsides over annuities but lower growth potential than stock. Still, the upside over annuities is that you have more stability with less risk than stocks and less upside during a bull market. 

Finally, shifting your money into a 401(k) account will offer you the most tax advantages and a broader set of investment choices. This is especially worth considering if you are still working and have employee matching, even as a baby boomer, which isn’t impossible to think you might still be working in some capacity during retirement.