Annuities: The Real Cost of a ‘Guaranteed’ Income Stream

Written by Grace Stolberg

At our firm, we come across many retirees who either already own an annuity or are being offered one. The pitch is almost always the same: “It provides a guaranteed stream of income for life!”

That sounds comforting, right? Who doesn’t like the sound of “guaranteed”? Unfortunately, that guarantee often comes with a long list of tradeoffs, most notably the slow erosion of your purchasing power and financial flexibility over time.

Part of the reason annuities no longer hold the same appeal as they once did is that retirement itself has changed. People today are living longer and working longer than ever before. Social Security has continuously pushed back the stated “full retirement age” from 65 to 66 and 10 months, and now to 67. 

Retirement as we picture it today, filled with travel, family, and leisure, really took shape in the 1950s and 60s. At that point, most retirees were covered by pension plans, and the system worked largely because of one key factor: longevity. For a 65-year-old retiring in 1960, the average life expectancy was approximately 70.2. That meant roughly five years of enjoying retirement, spending time with family, maybe taking a few trips, and drawing a pension that could comfortably support their needs.

Now fast forward to today. A 65-year-old retiring in 2025 in the United States has an average life expectancy of 83.2 if male, and 85.7 if female. Retirement has gone from lasting five years to nearly two decades. A multi-decade retirement comes with a far greater need for an increasing stream of income and flexibility, as inflation now has a far greater ability to meaningfully deplete your purchasing power over time.

Inflation quietly eats away at your income every year. A fixed annuity paying you the same amount for life might feel dependable, but the value of those dollars steadily declines. Even the slightly more attractive annuity options that guarantee a growing income benefit each year have historically failed to outperform traditional long-term equity investing. Over time, the compounding growth that comes from owning quality businesses has simply outpaced the modest increases offered by most annuity products. That $50,000 annual income you lock in today may feel fine at 65, but by age 85, it might buy you half the groceries and half the freedom it once did.

Whenever I evaluate annuity options for our clients, I compare them to a simple, conservative alternative: taking the lump sum instead of the annuity and investing in high-quality businesses. Our analyses use cautious assumptions, such as a 6% annual growth rate and a 3 to 4% withdrawal rate. Even under those modest projections, the annuity seems to fall short in terms of both lifetime projected income and future legacy value.

This brings us to another important factor: what happens at the end of your life. Most annuities either stop entirely at the owner’s death or continue at a reduced benefit for the surviving spouse, then end completely when both pass. By contrast, when a lump sum is invested in an IRA or a brokerage account, those assets don’t die with you. The account is free to pass from generation to generation, so long as you don’t spend it down during your lifetime. That flexibility is one of the most powerful advantages of investing outside an annuity. You maintain control over your capital, your income options, and your legacy.

One of our clients faced this very decision in 1991. He could take a lifetime annuity paying $16,800 per year, or roll over his $313,104 balance to an IRA and invest it. He chose the lump sum after meeting with my colleague and the cofounder of our firm, Peter O’Keefe. By 2001, just ten years later, his account had grown to $937,674, and he had already withdrawn $32,854 that year alone. Outside of a small $30,000 rollover the following year in 2002, he never added new funds. Today, that same account sits at $4,133,316.65. If he had instead went with the annuity option, he would have received $571,200 in income since 1991 to present day. In reality, he has withdrawn $2,356,173 over the years. His required minimum distribution for 2025 alone is $331,447.

Let’s revisit that “guaranteed” annuity he was offered for a moment. The $16,800 promised back in 1991 is 5% of his current year distribution. Which would you pick?

This story is not unique. It is simply what happens when you invest patiently and allow compounding to do its work. Albert Einstein supposedly called compound interest the “eighth wonder of the world.” Whether or not he actually said that, he was right about its power. When you annuitize, you effectively trade away compounding. You hand over your principal, accept fixed payments, and lose the ability for your wealth to grow.

Some annuities try to address this by offering “market participation” or “step-ups” tied to performance, often capped at something like 6-8% per year. But those features come at a hefty cost, whether through high internal fees, restrictive riders, or opaque formulas that even seasoned advisors struggle to decode, let alone explain to clients.

And that brings us to one of the most overlooked aspects of annuities: the fees. Most annuities carry several layers of costs that quietly eat away at returns. There are annual administrative fees, expense ratios for the underlying investment options within the annuity, commissions to the person who sold the product, additional rider fees, and mortality and expense risk fees. That last one alone typically averages 1.25% of the account value per year. To put that in perspective, this single charge is higher than the average management cost charged by a financial advisor on a $1 million portfolio, which is about 1.02% nationally. These costs, stacked together, can and will meaningfully reduce your long-term growth and income potential.

Here is the golden rule: anytime you see the word “guarantee” in an investment product, understand that you are paying for it. And the cost is not just in dollars, it’s in lost growth potential, lost flexibility, and peace of long-term peace of mind.

That said, not all annuities are the wrong choice. Some people truly cannot tolerate market volatility. If the emotional comfort of a predictable payment stream helps you sleep at night and prevents panic-selling during market downturns, then an annuity can serve a purpose in your portfolio. But for most retirees, and certainly for those with sufficient savings and a well-built portfolio, the better path is maintaining control of your money, letting it grow, and allowing your income to rise naturally with the market over time.

Annuities are designed to make uncertainty disappear. But in doing so, they often strip away opportunity, flexibility, and long-term financial growth. If you can handle a bit of short-term volatility, there is a far greater guarantee available: the long-term power of owning great businesses, compounding returns, and keeping control of your wealth.

Disclosure:

O’Keefe Stevens Advisory is a SEC registered investment adviser located in Rochester, New York. Registration does not imply a certain level of skill or training. The opinions expressed in this article are those of the author and are provided for informational purposes only. They should not be construed as individualized investment advice or a recommendation to buy or sell any security, annuity, or investment strategy. The examples and performance figures referenced are for illustrative purposes only and do not represent the performance of any specific account, investment, or product. Past performance is not indicative of future results, and all investments involve risk, including the possible loss of principal. Certain information contained herein has been obtained from third-party sources believed to be reliable, but we do not guarantee its accuracy or completeness. Readers should consult their financial, tax, and legal professionals before making any investment decisions.

For more information about O’Keefe Stevens Advisory, including our Form ADV and a complete list of disclosures, please visit https://www.okeefestevens.com.