The Hidden Risks of Not Using an Annuity in Retirement

The allocation question does not have a single correct answer because the appropriate percentage depends on the household’s specific income needs, other guaranteed income sources, risk tolerance, and liquidity requirements. The framework most financial planners use is income flooring: identify the essential monthly expenses that must be met regardless of market conditions — housing, utilities, food, healthcare, insurance — and build a guaranteed income floor from Social Security, any pension income, and annuity income that covers those essential costs entirely. Once the guaranteed floor covers essentials, the remaining portfolio can be allocated to growth-oriented investments for discretionary spending, emergency reserves, and legacy goals without the anxiety of needing market performance to fund survival expenses. The portion of the portfolio that goes into an annuity to fund the income gap between Social Security and the essential expense floor is highly individual. A retiree with a $4,000 monthly Social Security benefit and $3,500 in essential monthly expenses has a small gap requiring minimal annuity income. A retiree with $1,800 in Social Security and $4,500 in essential expenses has a large gap requiring substantial annuity funding. What matters is not the percentage of the portfolio in the annuity but whether the guaranteed lifetime income produced covers the income floor reliably. Reviewing how Social Security and annuities work together as coordinated income sources helps determine the exact funding needed from the annuity to close that gap without over-allocating capital into illiquid insurance structures.

Not necessarily — and in many cases, having a guaranteed income floor from an annuity can actually allow retirees to maintain higher equity exposure more comfortably than they could without the guaranteed income layer. The primary reason retirees reduce equity exposure is not investment conviction — it is cash flow anxiety. When the portfolio is the only source of retirement income, a 30% market decline creates an immediate practical problem: withdrawals must continue regardless of market conditions, forcing the sale of depreciated assets. When guaranteed annuity income covers essential expenses, market declines in the equity portfolio become an abstract paper loss rather than an immediate income crisis. This structural separation — guaranteed income for essentials, growth assets for discretionary and legacy — allows the retiree to hold equity positions through downturns without being forced to sell, which improves long-term portfolio outcomes. Sequence-of-returns risk is the specific mechanism by which forced equity sales during early retirement downturns permanently impair portfolios. The annuity income floor eliminates the mechanism that makes sequence-of-returns risk so damaging — removing the need to sell into declining markets. Reviewing the full picture of annuity benefits in this context makes clear that annuities and equities are not competing allocations — they serve different functions in a well-designed retirement income architecture.

The 4% rule — withdrawing 4% of the portfolio annually, adjusted for inflation — was developed from historical data showing that this rate had a high probability of sustaining a 30-year retirement in most historical market scenarios. It remains a widely used guideline, but it has meaningful limitations that become more consequential as retirements lengthen and interest rate environments shift. The rule was developed using historical U.S. equity and bond returns from periods that included strong tailwinds. There is no contractual guarantee that the next 30 years will produce the same results. The rule also produces highly variable outcomes depending on the sequence of returns in the early years of retirement — a retiree who began withdrawals in 1999 or 2007 experienced substantially different outcomes than one who began in 2010, even applying the same 4% withdrawal rate. For retirees who need reliable income for 35 years or more — particularly for someone retiring at 60 or 62 — the probability of 4% withdrawal success, while historically reasonable, is not a contractual guarantee. An annuity, by contrast, contractually guarantees its income payments regardless of market performance. Understanding the full range of annuity options for retirees without pensions shows how the guaranteed income component can backstop the 4% rule by ensuring a minimum income floor regardless of whether the portfolio sustains the withdrawal rate over the full retirement horizon. This does not mean the 4% rule is wrong — it means the most resilient retirement income plans combine systematic withdrawal strategies with a guaranteed income floor rather than relying exclusively on either approach.

Healthcare cost inflation is one of the most significant and underestimated financial risks in long retirement planning. Healthcare spending tends to increase with age — spending in your 80s is substantially higher than spending in your 60s — and healthcare cost inflation has historically outpaced general CPI by a meaningful margin. A retiree who budgets $800 per month for healthcare at age 65 may face $2,000 or more per month by age 80 in real terms, representing a purchasing power problem that flat pension income or flat annuity income cannot solve without additional planning. Annuities address healthcare inflation risk in two distinct ways. First, fixed indexed annuities may generate above-CPI credited returns in years of strong index performance, allowing the accumulation value and potential step-up income base to grow faster than a declared-rate fixed product in favorable years. Some GLWB riders include step-up provisions that increase the guaranteed income amount when the account value reaches new highs, providing a mechanism for income to grow over time. Second — and more fundamentally — having guaranteed income that covers essential expenses reduces the need to liquidate investment assets for healthcare costs, preserving growth assets for the compounding that partially offsets inflation over time. The combination of guaranteed income covering baseline costs plus a growth portfolio for the inflation-driven cost increases over time represents the most practical approach to healthcare inflation risk in retirement. For retirees also evaluating long-term care insurance as part of their healthcare cost protection strategy, both a guaranteed income floor from an annuity and long-term care insurance serve complementary roles in addressing the two distinct healthcare financial risks in retirement: ongoing inflation of routine healthcare costs and the potential catastrophic cost of long-term custodial care.

If your Social Security benefit and pension income together cover your essential monthly expenses with a meaningful buffer, and you have substantial liquid investment assets for discretionary spending, emergencies, and legacy goals, then you may genuinely not need an annuity. The annuity’s primary role is to fill the gap between guaranteed income and essential expenses — if that gap is already closed by other guaranteed sources, the marginal benefit of adding an annuity for income purposes is lower. However, even in this scenario, annuities may serve other purposes that remain relevant. Principal protection: if a portion of your investment portfolio is in conservative fixed-income instruments, repositioning those assets into a MYGA may improve the declared rate while adding tax deferral advantages over taxable bond equivalents. Legacy efficiency: a non-qualified annuity with a beneficiary designation passes assets directly to heirs and bypasses probate — relevant even when income is not the primary need. The honest answer for retirees with strong Social Security and pension coverage: evaluate whether the annuity solves a problem that actually exists in the retirement plan. If the income floor is already secure and liquidity is ample, the annuity’s value may be primarily in tax deferral and wealth transfer efficiency rather than income generation. Reviewing whether annuities are a good or bad fit in the specific context of an already-well-covered retirement plan provides the honest framework for that evaluation.