Ask a Fool: Should I Buy an Annuity for Retirement Income?

Q: I have a substantial amount of money in my 401(k), but I'm wondering if I'd be better off buying an annuity and guaranteeing myself a certain amount of retirement income.

An annuity may seem like a great idea for a worry-free retirement. After all, you give a company some money, and you get a stream of guaranteed income for the rest of your life, starting either right away (immediate annuity) or at some point in the future (deferred annuity). This can certainly give retirees peace of mind, especially when compared to a stock and bond portfolio that can fluctuate in value significantly over time.

However, there are a few things you need to know about annuities before you consider one.

First, annuities are notorious for having high commissions and fees. It's not unheard of for annuities to pay commissions of up to 10% to salespeople, and some annuities (especially variable annuities) can charge hefty annual fees.

As a result, it's generally a better idea to approach an insurance company that sells annuities directly, as opposed to buying one from an advisor or salesperson. If you are working with an advisor, ask if he or she is bound to the fiduciary standard. If not, it's highly likely that the annuity you're being sold has a high commission attached to it.

Also, it's important to realize that an annuity is only as safe as the insurance company that sells it, so look for the highest-rated companies, even if it means a slightly lower monthly payout.

Finally, annuity payouts are based on interest rates, which are rather low right now. In fact, there have been times when annuities paid out nearly double what they do today. If interest rates continue to rise, annuity payouts should rise as well, making the income stream you can buy significantly more attractive.

For the majority of retirees, I'm a big fan of 401(k)s or other retirement accounts filled with stock- and bond-based investments. However, as long as you know what you're getting into, an annuity isn't necessarily a bad idea if worry-free income is a priority for you.