Taking the Mystery Out of Annuities

Ensuring a guarantee of lifetime income during retirement is an essential element of any sound retirement strategy. And guaranteed lifetime income is the fundamental principle of an annuity. So why don't annuities show up in more peoples' retirement portfolios? It's largely a matter of misunderstanding and confusion about the true value an annuity can deliver.

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  • A 2009 study from McKinsey & Company showed that the average U.S. household faces a retirement savings shortfall of $250,000.2
  • The Employee Benefits Research Institute (EBRI) reports that 47.2% of Americans approaching retirement are at risk of running out of money.3
  • TIAA-CREF research reveals that about 40% of American adults report they aren't saving enough for retirement.
    • Most people would like to increase their savings, but more than three-quarters of those believe they won't succeed in doing so.
    • Most people report that they have little idea how to change their behavior. More than 80% of those who believe they aren't saving enough for retirement report that they don't know how to get started.4

What's more, the dominant retirement savings model – building wealth – doesn't address the most basic risks and uncertainties associated with achieving lifetime financial security: how to assure that individuals can plan and act over the long term to support themselves adequately in retirement.

To address these shortcomings, TIAA-CREF is placing renewed focus on the concept of "guaranteed income" as a linchpin of retirement planning. We see this income as the reservoir of savings that you cannot deplete – providing security amid the uncertainty of not knowing how long you will need a steady income stream.

Guaranteed income also serves as a hedge against changes to your health and employment status. By establishing the means to realize guaranteed income and create an income floor — the absolute minimum you need to survive — the payouts from the guaranteed resource will pay for essential expenses such as food, home and taxes throughout old age.

About Annuities — Minus the Mystery

Annuities are uniquely designed to deliver a guaranteed income. But they are one of the most misunderstood investment products and are often the target of unfair criticism. Let's clear up some of the confusion and start with a basic explanation of how annuities work.

An annuity is best thought of as a contract between an individual and a financial services firm that is also registered as an insurance company. Under this contract, you commit funds to a firm that manages the annuity, and it invests your funds as well as those of other investors. When you decide you want to start receiving annuity distributions (typically when you are 59½ or older, in order to avoid tax penalties), the firm is obligated to make payments to you.

Many annuities, including those offered by TIAA-CREF, offer a broad range of accumulation and payout options, serving people of different ages, incomes and financial situations. And annuities offer a flexibility not found in many other investment products. In some cases, you have the freedom to reallocate your assets if there is a change in your financial status or in market conditions. For example, as you grow older, you might decide you'd like a steadier income stream. With variable annuities, you can take some of the annuity income you are receiving from more volatile investments such as stock (equity) accounts and transfer it to more conservative investment choices such as fixed-income accounts.5 And annuities differ from individual retirement accounts in that individuals who are still working are not required to begin making withdrawals at the age of 70½.

There are two different kinds of annuities: "fixed" and "variable."

Fixed annuities
Fixed annuities provide both tax-deferred asset accumulation and lifetime income. This makes them particularly well-suited to serve as the foundation of a complete retirement plan.

Safety and Stability
A fixed annuity guarantees safety of principal and a specified interest rate. Unlike stocks, bonds and other variable investments, the annuity provides some upside return potential with no downside risk. As a result, your annuity account balance never declines — even during periods of extreme market volatility and negative returns for other types of investments.

U.S. stocks plummeted nearly 45% between December 2007, when the "Great Recession" began, and March 9, 2009, the recent bottom for most equity markets. A fixed annuity, however, would have held its value and increased by the amount of guaranteed interest paid under the terms of the annuity contract.

Fixed annuities are excellent portfolio diversifiers because their returns historically have had low correlations with those of other asset classes, such as stocks and bonds. Diversification can help reduce overall volatility and enhance long-term return potential, which may make it easier for you to maintain an appropriate asset allocation during periods of market volatility.

Potentially Higher Retirement Income
When you contribute to a low-cost, fixed annuity over the course of a working career and convert the accumulated savings into a guaranteed stream of lifetime income, you may benefit from the fact that your contributions were applied during different interest rate environments. Individuals who wait until retirement to purchase a fixed life annuity may run the risk of investing funds during a low interest rate environment, with consequently lower income payments.

Variable Annuities
Like fixed annuities, variable annuities can also provide tax-deferred asset accumulation and lifetime income. But they differ in important ways. While a fixed annuity provides a minimum level of guaranteed income, the income under a variable annuity is based on the performance of various investment sub-accounts (thus "variable" and not "fixed"), and the amount of the payout typically resets monthly or annually. Moreover, while income is guaranteed for the duration of the investor's life, the amount of such income can vary significantly over time.

Potentially Higher Growth
Variable annuities invest your capital in both stocks and bonds. This means you can potentially realize higher long-term returns than if you had invested in a fixed annuity, though there is also greater downside risk. For this reason variable annuities are often used to help mitigate inflation risk.


The extreme volatility of the stock market spanning 2008 and 2009 provided a potent reminder of the risks associated with investing. For individuals entering retirement, the steep market decline had the potential to disrupt years – or even decades – worth of financial planning.

But annuities, which provide a guaranteed income as individuals enter retirement, can play an important part in helping to strengthen your financial security and achieve other long-term financial goals.

Building your legacy