One of the toughest hurdles for retirees is working out how to pay themselves and then spending the money.
For decades, the pressure has been to save. When the time comes to start drawing on those funds, it can be paralyzing.
Personal finance expert Jean Chatzky has a solution: Use an annuity to provide a paycheck.
To annuitize essentially means to convert a lump sum portion of a retirement account into a contract that pays you a fixed monthly amount for a specified period or for the rest of your life.
The trouble is that annuities sold by insurance companies have a bad undertone for many people. They can be difficult to understand and typically come with a variety of fees. It's hard to know what the real cost is and what the penalties are if you need to tap the money for an emergency.
"There were a lot of people with a lot of criticisms about annuities, and these criticisms have started to change," Chatzky told Yahoo Finance. "It's only in the last decade that I have started to realize that [annuities] are yet another financial tool, like investments are financial tools, that have a valid place in the landscape."
Chatzky is the founder and CEO of HerMoney, a columnist for AARP, and a research fellow with the LIMRA Retirement Income Institute.
For her, the real selling point is that an annuity can function like a regular paycheck, providing the same sense of security.
"It's not the size, it's the frequency," Chatzky said.
Researchers have found at all levels of wealth that people who had their money in an annuity that sent them a paycheck typically spent twice as much as those relying on their own calculations about how much to pull from what account and when to pay themselves, according to Chatzky.
"They are able to spend because they know that there is another paycheck coming," she said. "This is as much of a mind game as it is a financial one."
Annuities are contracts between you and an insurance company. You give an insurance company a lump sum, and they provide a monthly check for a certain amount of time. That stream of income could start immediately or at a later date, lasting for a fixed period of time or until you die, depending on the terms.
The amount you get paid each month is calculated based on a variety of factors that include the amount you put into the annuity, your age, gender, and the current interest rate.
There are a few drawbacks. You cannot, typically, take refunds, so once you enter an annuity contract, you can't go back or change the amount you get each month. You can't name a beneficiary, which means that when you die, the income payments stop, though some insurers offer the option to add a spouse.
There are two main types of annuities: a fixed annuity and a variable annuity. A typical fixed annuity works like this. You give an insurance company a chunk of money, say $100,000, and the company will send you $7,500 a year, or $625 per month, for every month for the rest of your life. It's very straightforward.
Fixed annuities get slightly more complicated when it comes to couples. When one spouse dies, the surviving spouse still needs to receive income during their retirement. In that case, you want to include both spouses in a joint annuity, which lasts until the second spouse dies. That adds more risk for the insurer, so maybe that $100,000 annuity pays out $7,000 a year rather than $7,500 a year to accommodate both people.
With a variable annuity, you provide a lump sum to the insurance company, which invests the money and in turn provides you a lifetime check every month, but the amount can go up or down, depending on how the investments perform. So if the company's annuity is tied to, say, the S&P 500 stock market index, your monthly check increases when the index is up and the check shrinks when the market goes down.
But — this is key for retirees — your monthly check can't drop too much, even in a variable annuity, because there are protections built in, even if the market dips.
Like all insurance contracts, annuities have different benefits, riders, and rules, which affect what you pay for them and how much you get each month.
What happens if I need a portion of my money back? What happens to the annuity if I die? Are you a fiduciary — working in my best interests? Could my payments increase with inflation? Can you provide a list of all the fees I'm paying? And what is your commission from this sale?
These are all good questions to ask before entering a contract that would be hard to unwind. And since these are notoriously complex, it's best to vet them with a financial adviser who is your fiduciary.
Annuity products are better than they used to be, Chatzky added. "They're more transparent. They're easier to understand. The industry listened to people's complaints about not being able to get your money out once you put it in."
To be clear, she's not suggesting that an annuity is a total solution.
"This is a solution for about a third of your retirement money at most," she said. "It's an amount that, when you add it to whatever you're getting from Social Security, should be enough to cover your needs and those things you really want. But the rest of your money should be invested, and it can be invested more aggressively once you've done this."
One reason for annuities' appeal is that no one wants to see their retirement savings fall.
Fewer than 1 in 3 retirees are comfortable drawing funds from their savings, and 7 in 10 say it's very important that their nest egg doesn't shrink in retirement, according to a recent report from Corebridge Financial.
The truth is, most folks don't have the financial education to figure out how to make their retirement savings last for the rest of their lives on their own.
"We've got to take the assets that we've spent years and years and years accumulating in our 401(k)s and figure out, largely on our own, how to make it last, and that's scary." said Chatzky, who collaborated on the report and is the author of a new book, "The Forever Paycheck: The New Retirement Strategy to Spend More, Worry Less, and Never Run Out of Money."
An annuity can help remove a lot of that guesswork, providing a set amount you know you can count on every month.
In the end, the annuity decision comes down to your tolerance for risk.
"If you're more risk-averse, you're going to want the guarantees that you get from an insurance solution," she said. "If you've got a greater degree of FOMO and the markets go on a tear in a good way, and you are going to regret the fact that you have pulled money out and put it in an insurance policy, then you're going to be better off sticking with investments."
Nonetheless, she is sticking to her message: "I believe that putting some savings in an annuity will prevent this emotional hand-wringing down the road for the young millennials and Gen Z."
Kerry Hannon is a Senior Columnist at Yahoo Finance. She is a career and retirement strategist and the author of 14 books, including "Retirement Bites: A Gen X Guide to Securing Your Financial Future," "In Control at 50+: How to Succeed in the New World of Work," and "Never Too Old to Get Rich." Follow her on Bluesky and X.
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