We recently featured a story on how to get more people to buy annuities. Readers had a lot of questions about it.
The article -- written by Olivia S. Mitchell, a professor at the University of Pennsylvania's Wharton School -- recommended that annuities become a default option in 401(k)s and other defined-contribution retirement plans. That currently isn't allowed, so Congress would have to authorize it.
Many WSJ readers had doubts, raising questions about the complexity, viability and costs of annuity products. So we asked Mitchell to address some of those concerns.
Here are some of the questions and her answers:
Aren't annuities too complex for the average investor when it comes to understanding liquidity, costs and commissions?
Concerns about annuity complexity are common, and for good reason: The annuity marketplace offers both simple income products as well as highly engineered contracts that can overwhelm the average investor with features such as surrender charges, participation rates, guaranteed-income riders and multiple embedded fees. Annuity pricing is often opaque, and the products themselves are frequently sold through commission-based channels, making it difficult for investors to distinguish between necessary insurance features and costly add-ons.
Nevertheless, the complexity of some annuity products shouldn't obscure the simplicity of others.
Most academic researchers favor single-premium immediate annuities (SPIAs) and deferred-income annuities $(DIA)$. An SPIA is an insurance contract where the buyer pays a lump sum to an insurer, in exchange for guaranteed income payments that begin almost immediately. With a DIA, the individual pays one or more premiums to an insurer in exchange for guaranteed income payments that begin at a future date. There are no asset-based fees, no moving parts and no market assumptions to monitor. These products function much like Social Security or traditional defined-benefit pensions, offering longevity protection rather than investment performance.
For retirees seeking lifetime income without navigating complicated contracts, focusing on these plain-vanilla income annuities while keeping growth assets in low-cost market portfolios can strike an effective balance. Complexity becomes optional, not unavoidable.
What happens if the annuity issuer becomes insolvent? Isn't that a big risk?
In the U.S., annuity guarantees don't disappear if an insurer becomes insolvent. Instead, every state has a guaranty association system that steps in to protect policyholders up to statutory limits (typically $250,000 per owner per insurer, though limits vary slightly by state).
If an insurer becomes financially impaired, state regulators take control and either rehabilitate the company or transfer its annuity obligations to a financially stronger insurer. Historically -- even in major failures such as that of Executive Life Insurance Co. in the early 1990s -- annuity holders continued receiving payments, with only some reductions for those whose benefits exceeded state coverage caps.
Such failures are rare. The life-insurance industry in the U.S. is one of the most tightly regulated financial sectors, with stringent capital requirements, regular stress testing and conservative investment mandates. Insolvencies occur far less frequently than bank failures, and large, well-rated insurers have extremely low default probabilities. Even when failures have occurred, policyholders have generally been made whole up to guaranty limits.
For retirees seeking extra protection, a simple strategy would be to diversify across multiple highly rated insurers, ensuring that each contract remains below the coverage limit in the purchaser's state.
Social Security is basically an annuity. So why would you tie up even more of your investments in another annuity?
The Social Security system pays retired Americans a vital source of lifetime income, so it is reasonable to ask whether buying an additional annuity would concentrate too much wealth in one payout type.
While the system functions like an annuity, it differs in important ways. Social Security benefits are financed primarily from payroll taxes rather than an investment pool, so the system isn't backed by accumulated assets as are annuities. Benefits are indexed to inflation and payments rise substantially for those who delay claiming benefits until age 70. The Social Security program also faces a projected funding shortfall in the 2030s, and under current law, benefits will be cut by 24% across-the-board if Congress doesn't act.
Taken together, these structural and policy risks suggest that Social Security alone may not fully shield future retirees from longevity, inflation or political uncertainty.
Many retirees can strengthen their financial resilience by supplementing Social Security benefits with an additional income annuity. Retirees who pair a stable base of guaranteed lifetime income with a diversified investment portfolio will be able to spend more confidently without running out of savings in advanced age. A simple immediate or deferred-income annuity provides a second layer of protection, funded by mortality credits that markets cannot replicate, while also diversifying political and funding risk. (Mortality credits are the extra income people with lifetime annuities receive when others in the pool of annuity holders die earlier than the average life expectancy.)
The objective isn't to lock up all assets, but to secure essential expenses while preserving liquidity and growth potential.
Unlike other investments in your 401(k), if you die, the value of the annuity doesn't go to your heirs. Is that a big negative?
The answer depends on your priorities. Losing the remaining value at death is the trade-off that allows the annuity to provide guaranteed lifetime income, which benefits people who live longer than average. If leaving money to your heirs matters, you can buy life insurance and name them as beneficiaries, or choose annuity options with a period-certain guarantee, though the latter reduce your monthly payment.
What about the inflation risk? Doesn't that make the annuities worth less if you lock in low rates or return?
Inflation risk is a genuine drawback of traditional fixed annuities, which pay a level nominal income that steadily loses purchasing power. Retirees who lock in today's interest rates also are locking in the real value of future payments, leaving them exposed if inflation stays elevated.
But inflation erodes most safe assets, not just annuities. A government bond ladder also pays fixed nominal amounts and -- unless built with Treasury inflation-protected securities (TIPS) -- suffers the same long-term decline in real income. The mortality credits, which grow as retirees age, help offset some inflation erosion, although they don't eliminate it. A few U.S. insurers offer inflation-adjusted annuities, but their starting payouts are lower to reflect the cost of future increases.
Because no single product solves both inflation and longevity risk, many researchers recommend a blended approach: Use immediate or deferred-income annuities to secure efficient lifetime income, and keep a portion of assets in diversified portfolios including equities, TIPS, or real estate that historically have offered better inflation protection. Delaying Social Security benefits until age 70, which maximizes inflation-indexed lifetime payments, offers one of the strongest hedges against both longevity and inflation risk available to retirees.
In short, annuities carry inflation risk, but so do most fixed-income alternatives -- and a balanced strategy can manage it effectively.
How do annuities compare with alternatives such as a ladder of government bonds or keeping the money invested in the market?
Annuities, bond ladders and market portfolios each solve different retirement challenges, but only annuities insure longevity risk, or the risk of outliving one's savings.
A lifetime income annuity guarantees payments for as long as the retiree lives, enabled by mortality credits. These credits allow annuities to pay higher monthly benefits per dollar than a self-funded bond ladder. Simple immediate or deferred-income annuities are often cost-effective, relative to bonds once mortality credits are accounted for.
Bond ladders offer transparency, liquidity and predictable cash flows, while allowing retirees to retain control of their principal. Yet they don't provide longevity protection, prompting many retirees to underspend to avoid depleting their assets. And once the bonds mature, the income stops.
Market portfolios provide the highest long-term expected returns and maximum flexibility, but they come with significant volatility and don't guarantee against running out of money, particularly if market returns are poor early in retirement.
For most retirees, researchers often recommend combining these approaches: using immediate or deferred-income annuities to secure a baseline of guaranteed income, supplemented by market investments for liquidity, flexibility and growth.
Write to reports@wsj.com.
(END) Dow Jones Newswires
January 03, 2026 10:00 ET (15:00 GMT)
Copyright (c) 2026 Dow Jones & Company, Inc.
Comments