Is an Annuity a Good Investment? Benefits and Risks Explained

However, annuities can be complex and may involve material costs and constraints. If not selected and structured carefully, particularly in a cross-border context, investing in an annuity may meaningfully reduce net retirement outcomes.

This article will address the question of “Is an annuity a good investment?” by exploring the key advantages and potential risks of these retirement products. It will also identify the US expat profiles most likely to benefit from purchasing an annuity.

How Does an Annuity Work?

An annuity is a contract with an insurance company that converts savings, often contributed as a lump sum, into a series of regular payments you can receive in retirement.

For many US expats, annuities are commonly issued by US-based insurers and denominated in US dollars, which can affect taxation and long-term suitability.

The specifics of your annuity will primarily depend on the selected type and contract terms. For instance, you may select between two types of annuities depending on when the payouts will commence:

A traditional annuity provides fixed payments for a predefined period or for life, which can support budgeting and essential expenses. However, fixed annuities may be less flexible for retirees with variable spending needs and may be exposed to inflation risks.

You may address these risks by selecting between various alternative annuity options, such as:

• Escalating: Payments increase over time, either by a predefined percentage or based on a contractual formula intended to partially offset inflation.
• Variable: The annuity’s value and payouts fluctuate according to the performance of the underlying investments, and are therefore subject to market risk.
• Indexed: Returns are credited based on the performance of a market index, subject to caps, participation rates, and insurer-defined limits, with a certain degree of downside protection.

US vs Non-US Annuities: Why the Issuing Country Matters

For US expats, the country in which an annuity is issued can have a significant impact on taxation, reporting obligations, and overall suitability.

While annuities may appear similar across jurisdictions, their treatment under US tax law can differ materially depending on whether the contract is issued by a US or non-US insurer.

In general, US-issued annuities are designed to align with US tax rules and typically benefit from tax-deferred growth during the accumulation phase, provided they are structured in accordance with US tax regulations.

By contrast, non-US annuities may not qualify for the same tax treatment and can be subject to less favourable or more complex taxation, including potential annual taxation of income or gains, for US citizens.

Key differences for US expats

Because the US taxes its citizens on worldwide income, holding a foreign annuity does not remove US tax obligations and may increase compliance complexity. In some cases, foreign-issued annuities may also trigger additional US reporting requirements.

For this reason, US expats should carefully evaluate whether a non-US annuity offers any genuine advantage after accounting for taxation, reporting, currency exposure, and risk.

What Are the Main Benefits of Investing in an Annuity?

The primary advantage of investing in an annuity is enhanced financial security. Rather than gradually depleting your retirement fund, it can provide a consistent stream of income you may rely on throughout retirement.

As a result, an annuity can help reduce the risk of outliving your retirement savings. Subject to the terms of the contract and the financial strength of the issuing insurer, your income will not decrease below the guaranteed sum.

Additional benefits of investing in an annuity include:

• Tax-deferred growth: During the accumulation phase, the earnings within your annuity are typically not subject to US tax until you start taking distributions, provided the annuity qualifies for US tax deferral.
• Principal protection: Fixed and fixed indexed annuities are designed to protect your nominal principal from market losses, subject to insurer solvency and contract terms. This makes annuities suitable for individuals with low risk tolerance who prioritise income security over maximum growth.
• Death benefit features: Many US deferred annuities include a death benefit that your dependents can receive upon your passing, although these features vary by contract and may involve additional costs.
• Inflation hedging: Escalating annuities may help partially offset inflation, as distributions increase over time based on a predefined formula or selected rider, rather than remaining fixed in nominal terms.

Annuitising a portion of your retirement assets can provide a more stable income component within a broader retirement plan. However, it is not advisable to allocate your entire retirement portfolio to annuities because they may also expose you to significant risks.

What Are the Disadvantages of Investing in an Annuity?

The most notable disadvantage of an annuity is illiquidity. For many deferred annuities, the insurer will set a surrender period, which typically lasts between five and 10 years. During this period, you normally cannot make withdrawals without incurring considerable surrender charges.

Consequently, you may not be able to access the lump sum for several years, and in the case of lifetime annuities, access to the principal is often permanently forfeited once payments begin.

Other disadvantages to consider include:

• Limited protection: US annuities are not insured by the Federal Deposit Insurance Corporation (FDIC). Instead, limited protection may be available through state insurance guaranty associations, subject to state-specific limits and conditions, meaning insurer insolvency can still result in losses above those thresholds.
• Fees and commissions: Annuities are typically considered more expensive than alternatives such as ETFs or mutual funds, due to embedded fees, optional riders, and agent commissions built into the contract’s pricing.
• Lack of inheritance: A standard lifetime annuity without a death benefit provides no residual value for beneficiaries. Any remaining principal is retained by the insurer upon your passing, so premature death may lead to significant losses for dependants.
• Inflation risk: Although certain annuities offer inflation-adjustment riders, many provide fixed nominal payments, which can become less attractive in a prolonged inflationary environment.

Residency, Currency, and Lifestyle Risks for US Expats

While annuities can provide predictable income, their fixed and long-term nature introduces specific risks for US expats whose lifestyle, residency, or spending needs may change over time.

Currency risk: Most annuities are denominated in a single currency, commonly US dollars. If your living expenses are primarily in another currency, fluctuations in exchange rates may materially affect your purchasing power. A stable income in one currency does not necessarily translate into stable real spending capacity abroad, particularly during periods of heightened currency volatility.

Residency risk: Many US expats relocate multiple times during retirement. Because annuities are difficult or costly to unwind once established, changes in residency, healthcare systems, local insurance regulation, or local tax regimes may reduce their suitability over time.

Lifestyle flexibility: Annuities are generally best suited to retirees with predictable spending patterns. Irregular expenses, such as relocation costs, healthcare needs, or family support, are often easier to manage using more flexible income sources that allow access to capital when required.

For US expats, these factors mean that annuities are typically most effective when used as part of a broader, diversified retirement strategy rather than as a sole income solution.

Should You Buy an Annuity for Your Retirement?

Annuities are not equally suitable for all retirees, so you should consider purchasing one if specific scenarios apply to you:

1. You prioritise income security over growth.
2. You can secure a satisfactory annuity rate.
3. You can accurately estimate retirement expenses and do not require frequent access to lump sums.

You Prioritise Income Security Over Growth

Investing in an annuity may be sensible if you have accumulated sufficient wealth during your working years and now wish to convert a part of it into a more predictable stream of income. This product is particularly suitable for retirees who no longer wish to participate actively in market fluctuations and require an instrument that prioritises income stability.

More specifically, you should consider an annuity if you:

• Wish to minimise longevity risk and increase income predictability.
• Find comfort in income guarantees similar to a pension-style payment.
• Do not anticipate needing further asset growth in retirement.

If this is not the case, an annuity may not be an ideal solution, as it is typically not considered a growth-focused product.

You may invest in a fixed indexed annuity for a certain degree of market participation, but your returns will be subject to caps and participation rates set by the insurer. However, you would still benefit from contractual downside protection, as fixed indexed annuities typically include predefined floors below which credited returns cannot fall, subject to insurer terms and solvency.

A fixed indexed annuity is typically more complex than a standard option providing a fixed rate. If you are considering it, it is best to seek professional financial advice before committing significant capital.

You Can Secure a Satisfactory Annuity Rate

Although your annuity income primarily depends on the amount of annuitised funds, the applicable annuity rate is another critical consideration. The rate is defined by personal and external factors, such as:

• The payout duration.
• Current interest rates.
• Your overall health.

This variability requires attentive purchase timing. For instance, if interest rates are expected to decline after a period of elevated levels, you may wish to purchase an annuity sooner rather than later, provided it aligns with your broader retirement plan.

Similarly, you may obtain a more favourable rate if you are diagnosed with a condition that materially affects life expectancy. In this scenario, you may consider an enhanced annuity, which typically offers higher payments than standard options.

However, an annuity can still be effective if you are in good health and expect to live a long life, as the cumulative value of payments received over time may outweigh the impact of a lower initial rate.

If you are not certain whether it is the appropriate time to purchase an annuity or whether the rate offered is suitable, you may consult Titan Wealth International for assistance. Our advisers can help you assess available options within the context of your overall retirement strategy.

You Can Accurately Estimate Retirement Expenses

Annuities are better suited to retirees with a more clearly defined lifestyle than those who may incur significant or unpredictable expenses due to events such as:

• Upsizing a home
• Relocating to a new country
• Emergency family support

An annuity’s fixed nature generally does not accommodate costs that require substantial lump sums, so you must either rely on another income source for such purposes or ensure that you do not annuitise your entire retirement fund.

You may be permitted to withdraw up to approximately 10% of the contract value annually without surrender charges under certain annuity contracts. Any excess may result in substantial penalties, which could affect your financial stability.

For this reason, an annuity is more commonly used as a component of a diversified retirement plan rather than as the sole income source.

Even if you can predict expenses with a reasonable degree of accuracy, it is not possible to anticipate every future event that may lead to additional or unexpected costs.

Annuities vs Systematic Withdrawals: A Common Expats’ Dilemma

Many US expats compare annuities with systematic withdrawal strategies as alternative ways to generate retirement income. Each approach offers different trade-offs between flexibility, certainty, and long-term growth.

The table below compares the two approaches for US expats:

Systematic withdrawals from diversified portfolios may offer greater adaptability for expats with changing residency, currency exposure, or spending needs, but they require ongoing portfolio management and expose retirees to market and sequencing risk.

However, annuities can play a useful role in covering essential expenses that require reliable income regardless of market conditions, particularly for baseline living costs.

For many US expats, a combination of both approaches can provide a more balanced outcome, allowing retirees to secure predictable income while retaining flexibility and growth potential elsewhere.

How Are Annuities Taxed?

Gains realised within an annuity are generally not taxed during the accumulation stage. This deferral enables the annuity’s value to leverage compounding interest under US tax rules, without the burden of immediate taxation.

However, when you start receiving income from the annuity, distributions are generally taxed as ordinary income according to your marginal tax rate. This applies to domestic retirees and expats alike because the US imposes tax on the worldwide income of its nationals.

The taxation specifics depend primarily on whether your annuity is qualified or non-qualified:

Besides the US, your current country of residence may also tax annuity distributions. However, this does not necessarily mean you will pay tax twice on the same income, as the US has an extensive network of double tax treaties (DTAs) that may reduce or offset double taxation, depending on the treaty and the nature of the income.

In many cases, US tax treaties allocate taxing rights but do not fully exempt US citizens from US taxation due to the savings clause. Relief is therefore often provided through foreign tax credits rather than outright exemption.

Foreign tax credits are generally claimed using Form 1116, rather than Form 8833, which is used only to disclose specific treaty-based return positions.

Because each DTA differs in scope and application, it is essential for US expats to understand how the relevant treaty interacts with US domestic tax rules to avoid excessive taxation or potential non-compliance penalties.

US Tax Reporting and Compliance Considerations for Expats

In addition to income taxation, US expats should consider the reporting and compliance obligations associated with annuities, particularly when contracts are issued or held outside the United States.

Depending on how and where an annuity is structured, US citizens may need to disclose relevant income and, in some cases, associated financial accounts under US reporting rules.

Failure to comply with these requirements can result in significant penalties, even where no additional tax is ultimately due.

While the specific obligations vary based on individual circumstances, this added compliance layer reinforces the importance of understanding the cross-border implications of annuity ownership before committing capital.

When Annuities Are Usually a Poor Fit for US Expats

Although annuities can be effective in certain scenarios, they are not universally suitable for US expats approaching retirement. In many cases, the structure and constraints of an annuity may conflict with an expat’s financial or lifestyle objectives.

An annuity may be less appropriate if you:

• Expect to relocate or change residency in retirement.
• Require regular access to lump sums.
• Face high inflation in your country of residence without inflation-adjusted annuity features in place.
• Wish to prioritise inheritance planning.
• Prefer maintaining control over asset allocation.
• Are still focused on long-term capital growth rather than income stability.

In these circumstances, more flexible income strategies may provide better alignment with your goals and reduce the risk of locking into an arrangement that becomes difficult or costly to unwind over time.

Which Alternatives to Annuities Should You Consider?

You do not need to invest solely in a traditional annuity if you do not believe that it will serve your retirement goals. Rather, you may combine an annuity with other income sources to achieve greater diversification and flexibility.

For instance, you may choose to annuitise a portion of your retirement savings to secure predictable income, while keeping the remainder invested to support long-term growth and preserve access to capital.

Alternatively, you can employ a different strategy that aims to provide income stability without some of the constraints associated with annuities.

This may involve investing in diversified mutual funds, ETFs, dividend-paying stocks, or bonds, and withdrawing a set amount each year to generate ongoing income.

Doing so can help you avoid surrender charges and allow you to adjust withdrawals as your spending needs, residency, or market conditions change over time. However, this approach places longevity and market risk on the retiree rather than transferring it to an insurer.

Some US expats also use structured withdrawal strategies or bond ladders to cover near-term expenses, while keeping growth assets invested for longer-term needs. This can provide a degree of predictability without permanently relinquishing control of capital.

The most effective approach to ensuring retirement income security is highly individual and depends on factors such as residency plans, tax position, risk tolerance, and income flexibility requirements.

It is therefore advisable to consult a financial expert who can develop a personalised strategy aligned with your circumstances.