It is no secret that many people dream of retiring early. Countless workers who have been burned out by stress, long hours, and the desire for more freedom are considering retiring years, if not decades, before their traditional retirement age. According to a YouGov survey of 1,500 Americans, 59% want to retire before 65.

The reality? Only 40% of respondents believe they will be able to do so. Suffice it to say, to make that dream a reality, you need more than wishful thinking; you need a solid plan. One tool that sometimes gets overlooked in early retirement discussions? The annuity is sometimes not even on the table, and it should be.

Often, annuities are viewed as complex and tedious. Nonetheless, when strategically applied, they can provide a game-changing advantage for early retirees.

So, let’s learn how annuities can help you retire early, what the pros and cons are, and what you should consider before buying one.

Can an Annuity Help You Retire Early?

The short answer? Yes, but under the right circumstances.

When you step away from work, annuities can provide a reliable income stream to cover essential expenses — especially before other benefits kick in like Social Security or Medicare. If you’re worried about market swings eroding your savings, this steady income can bring peace of mind.

In practice, this might look like this;

• Bridging the income gap. An annuity can help bridge the gap if you can’t get Social Security benefits or certain retirement accounts until you’re 62 or older.
• Protecting against market risk. A big reason why early retirees hesitate is that they fear that if the market drops early in retirement, they will run out of money. But, due to the guaranteed payments, annuities provide stability.
• Providing lifetime income. If you’re worried about outliving your savings, especially if you retire young, an annuity can provide you with a lifetime of income.

Although annuities alone cannot fully fund early retirement, they are a valuable complement. A combination of savings, investments, and careful planning will maximize its benefits. To make sure it pays off in the long run, you must make sure its income aligns with your expenses, lifestyle, and long-term goals.

When deciding whether an annuity makes sense for your specific early retirement goals, always consult a financial advisor.

The Pros of Using an Annuity for Early Retirement

The following are a few compelling reasons to incorporate an annuity into your early retirement strategy;

• Predictable, guaranteed income. With an annuity, you can count on receiving regular, fixed payments in the future. As a result of predictability, you’re less likely to experience stress and anxiety caused by market fluctuations and periods of poor investment returns. This allows you to budget with confidence.
• Protection against longevity risk. With annuities, you avoid the risk of outliving your savings by receiving income for the rest of your life. For retirees who are looking at a 30-plus-year retirement, this provides a much-needed safety net.
• Health care cost management. Healthcare expenses can also be offset through annuities in the years preceding Medicare eligibility, which kicks in at 65. In some cases, annuities have riders for long-term care, which can help manage health care costs in retirement.
• Optional inflation protection. During retirement, inflation can diminish your purchasing power significantly. Depending on your annuity, you may receive cost-of-living adjustments (COLAs), which help keep your income payments in line with inflation.
• Freedom from investment management. An annuity lets you step back from the daily worries of investment decisions, market analyses, and portfolio rebalancing for a portion of your retirement funds. As your income is fixed, you can enjoy your newfound freedom rather than constantly monitoring your investments with a fixed or guaranteed annuity.

The Cons and Cautions of Early Retirement with an Annuity

Although annuities aren’t a magic bullet, they may not be the perfect solution for everyone seeking early retirement. Before committing, you should take into account these potential drawbacks;

• Limited liquidity. An annuity, particularly an immediate annuity, locks up a large amount of your money. Annuities can sometimes allow limited, penalty-free withdrawals (typically 10% per year). However, it can be challenging, costly, and even impossible to access large sums in the event of an emergency. An early retiree who might need unforeseen assistance must consider this lack of flexibility.
• Early withdrawal penalties (if under age 59½). Your regular income tax will be increased by 10% if you withdraw funds from a deferred annuity before age 59 ½. There are some exceptions, such as Substantially Equal Periodic Payments (SEPP), but these require careful planning.
• Potentially high fees. In some cases, annuities with complex and possibly high fee structures, particularly those with riders (add-on benefits), can be expensive. In addition to mortality and expense risk charges, administrative fees, surrender charges, and investment management fees may be involved. In the long run, these costs will reduce your income and return.
• Inflation risk (without protection). You’ll lose significant purchasing power over a long retirement if you don’t have inflation protection (a COLA rider) in your annuity, especially if you retire young. As living costs rise, a comfortable income today could seem much less substantial in 20 or 30 years.

Key Questions to Ask Before Using an Annuity for Early Retirement

If you’re serious about annuities as a part of your early retirement plan, you should ask yourself the following questions:

• What are my essential monthly expenses? To determine your living needs, you’ll need to know your baseline living costs.
• How much flexibility do I need? An annuity may not be enough to provide you with liquid assets if your early retirement plans include travel or a second home.
• How will I bridge the gap to Medicare (age 65)? When you retire before 65, you’ll need to buy private health insurance.
• Am I comfortable giving up control of my lump sum? By purchasing an annuity, you trade control of your money for guaranteed income. Ensure that this trade-off aligns with your comfort level.
• Do I need income for life, or just for a few years? Some people use period-certain annuities to cover only the early years of retirement before other sources of income kick in.

Alternatives to Annuities for Early Retirement

Despite their strength, annuities aren’t the only way to fund an early retirement. Early retirees employ a variety of strategies to achieve success;

• The 4% rule. According to this guideline, you should systematically withdraw 4% of your investment portfolio every year, adjusted for inflation. In theory, this withdrawal rate is sustainable over time. You don’t have to follow it exactly. However, it can be used as a guideline.
• Dividend income. It’s possible to generate a steady cash flow without selling your principal by building a portfolio heavily weighted towards dividend-paying stocks.
• Real estate. If you invest in rental properties, you can generate passive income that can fund your early retirement, but it also comes with its own set of responsibilities.
• Roth IRA conversions & SEPPs. A Roth conversion or utilizing Substantially Equal Periodic Payments (SEPPs) strategies can allow you to access retirement accounts tax-efficiently before age 59 ½. Still, you will have strict rules to adhere to.

Early retirees often find that combining strategies gives them the best combination of security, growth potential, and flexibility.

So… Is an Annuity Right for Your Early Retirement?

It depends on your personal goals, the level of risk you are willing to take, and your financial situation. If you value peace of mind and guaranteed income, an annuity may be a wise investment. However, it shouldn’t be your only tool.

Some people prefer a partial annuitization approach because it offers the best of both worlds. Generally, you would use a portion of your savings (e.g., 20-30%) to purchase an annuity that covers the non-negotiable living expenses, and the remainder would be invested for growth, flexibility, and discretionary spending.

Final Thoughts: Design Your Freedom Intentionally

Retiring early involves more than just walking away from work. This is about living a life you’re excited to live without worrying about running out of money.

Taking that journey can be a challenge, but understanding both the strengths and limits of an annuity can help you along the way. You should consult a financial advisor before making any major financial decisions. A financial advisor can help tailor a plan based on your specific vision of early retirement.

FAQs

What’s the main benefit of an annuity for someone retiring early?

Guaranteed income is the primary benefit. When you retire before Social Security or other benefits begin to kick in, annuities can be a great way to bridge income gaps and cover your essential expenses.

Are there tax penalties for using an annuity before age 59½ if I retire early?

Yes, typically. An IRS early withdrawal penalty of 10% applies to the taxable portion of withdrawals from non-qualified annuities before age 59 ½, in addition to regular income tax. However, there are some exceptions, such as Substantially Equal Periodic Payments (SEPP).

How much of my savings should I put into an annuity for early retirement?

There isn’t a one-size-fits-all annuitization strategy, but financial advisors often suggest partial annuitization. The idea is to use a portion of your savings (20-40%) to buy an annuity that covers your essential living expenses, while keeping the remaining portion invested for growth. As a result, security and liquidity are balanced while market returns are also possible.

Will an annuity keep up with inflation during a long early retirement?

Inflation protection is not always included in annuities. If you plan to retire for more than 30 years, you should select an annuity that provides for a Cost-of-Living Adjustment (COLA). As a result of this feature, your payments will increase by a certain percentage to help maintain your purchasing power against inflation. It is essential to understand that COLA-linked annuities generally offer lower initial payments.

What are some good alternatives to annuities for early retirement income?

Among the options available are the 4% Rule (systematically withdrawing 4% of your investment portfolio annually), building a portfolio that generates dividend income, or generating income from real estate rentals. To create a diversified and resilient income plan, many early retirees combine these strategies.

Image Credit: Marek Piwnicki; Pexels