Using Annuity Options Selectively to Secure Base Income

Why use annuities selectively rather than all-in?

Annuities can be valuable when used to secure the portion of your retirement income that pays for essentials (housing, health care, food, insurance). My experience working with clients shows that buying a single large annuity to cover every need often reduces flexibility, increases fees, and exposes you to insurer credit risk. A selective approach — purchasing annuities for a targeted income floor while keeping other assets invested — balances stability, liquidity, and growth.

Key reasons to consider selective use:

• Guaranteed baseline: Certain annuity options provide predictable monthly or yearly payments you can rely on for essentials.
• Flexibility: Keeping some assets in liquid or growth-oriented accounts maintains purchasing power and leaves funds for surprises.
• Fee and rider control: Buying only what you need can reduce the cost of riders (inflation protection, joint-life guarantees) and surrender penalties.
• Tax efficiency: Mixing qualified and nonqualified annuities, or using annuities inside IRAs thoughtfully, affects timing and taxation of income.

(For basic annuity definitions and types, see our core Annuity glossary.)

Which annuity options are best for securing base income?

There is no universally “best” annuity. The right option depends on your time horizon, need for inflation protection, health, and the balance between income certainty and liquidity. Common choices used selectively include:

• Immediate annuities: Convert a lump sum into immediate lifetime payments. Use these to cover essential monthly bills. They are simple and predictable but reduce liquidity.
• Deferred fixed annuities: Buy now, start payouts later. Suitable when you want higher future income and protection from market dips.
• Fixed indexed annuities: Provide some upside linked to an index with downside protection. Can be used when you want limited growth potential but protection from losses.
• Qualified Longevity Annuity Contracts (QLACs): Purchased inside retirement accounts to defer required minimum distributions and provide income late in life. QLACs are often used to insure against extreme longevity risk (see our QLAC glossary for details).

In practice, I often recommend blending an immediate annuity sized to cover essentials with laddered deferred annuities or a QLAC that begins later, so income increases over time while maintaining some liquid assets.

Related reading: When to buy an annuity — Questions to Ask Before You Commit (https://finhelp.io/glossary/when-to-buy-an-annuity-questions-to-ask-before-you-commit/), Annuity Laddering (https://finhelp.io/glossary/annuity-laddering/), Exploring Annuity Payout Options (https://finhelp.io/glossary/exploring-annuity-payout-options/).

A step-by-step selective-annuity framework you can use

1. Calculate your essential retirement budget

• List recurring, non-discretionary expenses (mortgage/rent, utilities, health premiums, basic living costs).
• Target an income floor percentage — many retirees aim to secure 50–70% of essentials with guaranteed income.

1. Map your guaranteed income sources

• Include Social Security, defined-benefit pensions, and any other pensions. The shortfall is where annuities are most useful.

1. Decide timing and duration

• Use immediate annuities for near-term needs.
• Use deferred annuities or a QLAC to cover older-age longevity risk (payments starting at age 80, for example).

1. Choose annuity types based on priorities

• If protecting purchasing power is paramount, compare inflation riders or indexing features (note these add cost).
• If you need growth, consider variable or indexed annuities with appropriate caps and participation rates.

1. Preserve liquidity and legacy goals

• Keep an emergency buffer (3–5 years of essential expenses) outside of annuities.
• If leaving money to heirs is a priority, prefer strategies that preserve a legacy (partial annuities, joint-and-survivor options, or maintaining non-annuity assets).

1. Compare insurers and costs

• Shop multiple insurers for payout rates and financial strength ratings (AM Best, S&P, Moody’s). Higher-rated companies offer relatively lower credit risk.

1. Review tax implications

• Nonqualified annuities are bought with after-tax dollars; earnings are taxed as ordinary income when withdrawn. Qualified annuities inside IRAs/401(k)s are taxed fully on distribution as ordinary income (see IRS Publication 575).

1. Get a second opinion

• Annuities are long-term contracts. Ask a fee-only advisor to model scenarios rather than relying on commission-based sales pitches.

Practical examples (illustrative)

Example A — The Essential-Payment Immediate Annuity

• Alice, 68, has Social Security that covers half her essentials. She buys an immediate life annuity sized to cover the remaining essential expenses. This reduces her worry about monthly bills and preserves her investment portfolio for discretionary spending.

Example B — Laddered Deferred Annuities + QLAC

• Ben, 60, buys a moderate deferred fixed annuity that starts at 65 and a small QLAC that begins at 80. The deferred annuity reduces drawdown pressure in early retirement, while the QLAC protects against living into very old age.

In my practice, clients who combine a small immediate annuity with later-starting contracts report fewer mid-retirement portfolio withdrawals and higher confidence about covering long-term care and health costs.

Costs, trade-offs, and common pitfalls

• Fees and surrender charges: Many annuities carry high fees and front-loaded commissions. Review surrender schedules and net-of-fee payout comparisons.
• Insurer credit risk: Annuity guarantees depend on the issuing company. State guaranty associations offer limited protection, but coverage limits vary by state and are not the same as FDIC insurance.
• Inflation erosion: Fixed payments lose purchasing power. Inflation riders exist but cost more and may cap upside.
• Liquidity loss: Money used to purchase an annuity is generally illiquid and may be subject to surrender penalties.
• Complexity: Variable and indexed annuities have contract features that can be confusing; always get clear illustrations and ask for projected net payouts under multiple scenarios.

The Consumer Financial Protection Bureau has practical buyer guides that help spot high-cost features and questionable sales practices (ConsumerFinance.gov).

Tax basics to keep in mind

• Nonqualified versus qualified: Nonqualified annuities use after-tax money; taxed only on earnings as ordinary income when distributed. Qualified annuities inside IRAs/401(k)s are fully taxable on distribution under ordinary income rules. See IRS Publication 575 for details.
• Exclusion ratio: For certain annuities, a portion of each payment may be treated as a tax-free return of principal until basis is recovered; after that, payments are taxable income.
• Required Minimum Distributions (RMDs) and QLACs: Putting deferred income into QLACs can delay required minimum distributions from retirement accounts in certain cases. Check current IRS guidance and consult a tax professional.

(IRS Publication 575: Pension and Annuity Income provides current rules on how annuity income is taxed — https://www.irs.gov/publications/p575.)

Questions to ask before you commit

• What portion of my essential expenses will this annuity cover?
• What happens to payments if the insurer becomes insolvent?
• Are there riders I need (inflation, survivor) and what do they cost?
• What surrender charges or withdrawal limits apply?
• How will this change my taxes and Social Security or Medicaid eligibility?

For a practical checklist and timing guidance, see our guide When to Buy an Annuity: Questions to Ask Before You Commit (https://finhelp.io/glossary/when-to-buy-an-annuity-questions-to-ask-before-you-commit/).

Final considerations and next steps

Using annuity options selectively is about creating an income floor that reduces worry without erasing flexibility. In my advisory work, the most durable retirements come from a mix: a guaranteed base from annuities sized to essentials, a laddered schedule for mid- to late-life income, and a liquid portfolio for growth and unexpected needs.

If you’re considering annuities, gather written illustrations, compare insurers, and have a fee-only planner model the outcome across market scenarios. Learn more about payout choices and how they affect guaranteed income at Exploring Annuity Payout Options (https://finhelp.io/glossary/exploring-annuity-payout-options/) and consider annuity laddering techniques to stagger income start dates (https://finhelp.io/glossary/annuity-laddering/).

Professional Disclaimer: This article is educational only and does not constitute individualized financial, tax, or legal advice. Your situation may require tailored strategies. Consult a certified financial planner and tax professional before buying annuities.

Authoritative sources:

• IRS Publication 575, Pension and Annuity Income: https://www.irs.gov/publications/p575
• Consumer Financial Protection Bureau (annuity consumer guides): https://www.consumerfinance.gov