Annuities are an essential component of the American retirement system, starting with Social Security. Why, then, do so few Americans understand them?

Most of us, it seems, are pretty much clueless about annuities. In one recent study, the American College of Financial Services gave older Americans a score of 12% out of a possible 100% for their knowledge of annuities, based on their performance on a short quiz.

Among a dozen knowledge areas measured in the school’s Retirement Income Literacy Study, the annuity ranked dead last. Respondents knew more about Medicare, life insurance and long-term care than annuities. The college surveyed 3,765 Americans ages 50 to 75 in August 2023.

In another recent survey, researchers from the TIAA Institute and Stanford University tested Americans on annuity literacy with a multiple-choice question that could not have been much simpler:

"Susan worries about living a long life and running out of money, the survey instructed. What is the best way for her to address that possibility?"

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The quiz offered these choices: She could buy an annuity. She could buy life insurance. There is nothing she can do. I don’t know.

Roughly half of the surveyed adults chose correctly. The January poll covered 3,876 adults.

“There is this question of why people don’t buy annuities. Part of it is that they don’t understand them,” said Gal Wettstein, a senior research economist at the Center for Retirement Research at Boston College.

What is an annuity, anyway?

Broadly stated, an annuity is a series of fixed, predictable payments made at regular intervals over multiple years. You can purchase an annuity yourself, or acquire one through work. A pension is an annuity an employer pays to a retired employee. Social Security is an annuity the government pays to you.

“I think it’s important for people to understand, they already have an annuity, and it’s called Social Security,” said Chester Spatt, a professor of finance at Carnegie Mellon University.

But when financial advisors talk about annuities, they are generally speaking about commercial annuities, a product sold by insurance companies that delivers a guaranteed income stream in retirement, generally until death. They come in several types. A fixed annuity, for example, delivers a guaranteed rate of return. A variable annuity yields variable returns, based on the earnings of an investment portfolio.

Only about 10% of Americans own commercial annuities, Wettstein said, citing Boston College research. Buyers tend to be upper-middle class, neither very rich nor poor. They are likely to live longer than the rest of us: Good genes, presumably, are one reason why they bought the annuity.

It would be great, many retirement scholars say, if a lot more of us bought annuities.

Why? Because most Americans count on Social Security to cover the bulk of their retirement expenses. And that annuity, alone, doesn’t provide enough monthly income to fund a comfortable retirement, at least not for many of us.

The average monthly Social Security benefit was $1,907, as of January. Yet, the average household run by someone 65 or older spends $4,345 a month, according to an analysis of federal statistics by the investment firm BlackRock.

Americans don't understand Social Security very well, either

Speaking of annuity literacy: Only about two-fifths of Americans understand the nuances of Social Security, according to the TIAA Institute, a research arm of the financial services nonprofit.

That’s how many adults correctly spotted a false statement about Social Security among three items in a multiple-choice question:

"A worker receives Social Security benefit payments if he/she becomes disabled before retiring": True.

"Social Security benefit payments will continue as long as an individual is alive, no matter how long he/she lives": True.

"The amount someone receives in Social Security benefits depends upon his/her earnings during the last two years of full-time employment": False.

The size of your Social Security check depends on average earnings for up to 35 years of work.

That only two-fifths of Americans got the question right "was a surprising result to us," said David Richardson, head of research at TIAA Institute, because Social Security "is so fundamental to retirement security."

He added, "We're not asking deep, difficult questions."

Half a century ago, much of the private workforce supplemented Social Security with private pensions, annuities that offered a guaranteed monthly benefit in retirement.

Are 401(k)s and IRAs doing the job of securing American retirement?

Over the decades, pensions have given way to the 401(k) and IRA, tax-advantaged savings accounts that allow Americans to build their own retirement funds.

The problem with 401(k)s and IRAs, retirement scholars say, is that they aren’t doing the job of securing Americans in retirement.

Wealthy people amass massive sums in retirement accounts. But middle-income workers tend not to save nearly enough, economists say. Fewer than half of Americans have any kind of retirement account, according to Census data.

Millions of Americans risk outliving their savings, retirement researchers say. Subsisting on Social Security alone, they could face a diminished standard of living in their final years.

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Annuities could, in theory, erase that risk.

“If you’re within 10 years of retirement, you’d better be looking at annuities to create your own pension, if you don’t have one,” said Dan Casey, an investment advisor in Bloomfield Hills, Michigan. “I haven’t met a soul who can retire on Social Security alone.”

Researchers theorize that most Americans don’t seriously consider commercial annuities for several reasons. Annuities are complex. Buying one isn’t so easy as signing up for a 401(k) plan through an employer.

"It's not an easy thing to do," Richardson said. "There's a lot of discussion around making it an easier thing to do."

Annuities are expensive, and they’re counterintuitive: In effect, they insure us against the risk of living too long, which many of us don’t recognize as a risk.

“It’s the risk of outliving your assets, because you lived longer than expected,” Wettstein said. “And that doesn’t sound like a bad thing, because everybody wants to live longer.”

Many Americans mistrust annuities

Many Americans mistrust annuities, sometimes with good cause.

“When you Google ‘annuities,’ you get these messages from people who just say, ‘I hate annuities, annuities are bad,’” said Michael Finke, a professor of wealth management at the American College of Financial Services, a private, nonprofit institution in King of Prussia, Pennsylvania.

“Annuities are a frequently abused financial product,” Finke said.

Regulators warn that the industry attracts scam artists, who try to con customers with deceptive sales practices, high-pressure pitches and inflated prices. The annuity industry is prone to scams, partly because the product itself is so complex, spelled out in contracts few people read.

Federal legislation has made it easier in recent years for employers to offer a high-quality commercial annuity as part of a 401(k) plan. And that could be a game-changer, retirement experts say.

On Wednesday, BlackRock, the world’s largest asset manager, announced the availability of LifePath Paycheck, a retirement savings vehicle that allows older workers to shift some of their 401(k) contributions into an annuity, targeted to an expected retirement year.

“As a society, we focus a tremendous amount of energy on helping people live longer lives,” said Larry Fink, the BlackRock CEO, in his 2024 letter to investors. “But not even a fraction of that effort is spent helping people afford those extra years.”

Daniel de Visé covers personal finance for USA Today and writes our free Daily Money newsletter, which offers finance tips and business news Monday through Friday.