Thinking about buying an annuity? Here’s a quick guide to help you avoid costly mistakes and make an informed decision. Annuities can provide steady retirement income, but they come with fees, risks, and long-term commitments. Before you commit, review these key points:
- Understand Annuity Types: Fixed, variable, and indexed annuities offer different levels of risk, growth potential, and income predictability. Choose based on your financial goals.
- Check Fees: Annuities often include commissions, management fees, and surrender charges that can reduce your returns.
- Know Tax Rules: Learn how qualified vs. non-qualified annuities impact your taxes and withdrawals.
- Plan for Inflation: Consider inflation-protected annuities to maintain your purchasing power over time.
- Evaluate the Insurer: Check the company’s financial strength and ratings to ensure your money is secure.
- Read the Contract: Review terms, guarantees, and penalties carefully to avoid surprises.
- Ensure It Fits Your Plan: Align the annuity with your retirement goals and overall financial strategy.
Quick Comparison of Annuity Types
| Annuity Type | Risk Level | Growth Potential | Income Predictability | Best For |
|---|---|---|---|---|
| Fixed Annuity | Low | Low | High | Stability and minimal risk |
| Variable Annuity | High | High | Low | Growth-focused investors comfortable with risk |
| Indexed Annuity | Moderate | Moderate | Moderate | Balancing risk and reward |
Take your time, ask questions, and consult a financial advisor to ensure the annuity fits your needs. The right choice can provide financial security, but the wrong one can lock up your money and limit flexibility.
How To Buy An Annuity in 2025 (Step by Step Guide)
1. Know the Main Types of Annuities
Understanding the three primary types of annuities is essential because each caters to different financial goals and levels of risk tolerance. The type you choose will shape your retirement income plan and long-term financial stability.
Recent U.S. annuity sales highlight an increasing interest in securing reliable retirement income.
| Annuity Type | Risk Level | Growth Potential | Income Predictability | Best Suited For |
|---|---|---|---|---|
| Fixed Annuity | Low | Low | High | Individuals prioritizing stability and minimal risk |
| Variable Annuity | High | High | Low | Those comfortable with market risks for potential growth |
| Indexed Annuity | Moderate | Moderate | Moderate | People seeking a balance of risk and reward |
Let’s take a closer look at each type.
Fixed Annuities
Fixed annuities provide a guaranteed interest rate for a set period, making them a predictable option for steady growth. Returns typically range between 3% and 6%, with most hovering around 3% to 4%. While these returns safeguard your principal from market downturns, they may not always keep up with inflation over time.
This type of annuity is an excellent choice for retirees who value income stability over aggressive growth. Fixed annuities invest in conservative options like government bonds and high-grade corporate debt, ensuring a consistent and safe income stream with minimal market exposure.
Variable Annuities
Variable annuities allow you to invest in subaccounts, which are similar to mutual funds and include options like stocks and bonds. These investments offer the potential for higher returns, but they also come with significant market risk. Depending on performance, you could lose some or all of your investment, including the principal.
While offering the highest growth potential among annuity types, variable annuities often come with higher fees, ranging from 2% to 8%, which can eat into your returns. Carefully review the investment options, associated costs, and contract terms before making a decision.
Indexed Annuities
Indexed annuities strike a balance between fixed and variable annuities. They credit interest based on the performance of a market index, such as the S&P 500, while ensuring that your interest rate never falls below zero. This setup offers some growth potential without direct exposure to market losses.
However, growth may be limited by caps, participation rates, or spreads. For instance, if the S&P 500 gains 15%, your return might be capped at a lower rate. On the downside, if the market drops, you’d earn 0% instead of taking a loss. Many indexed annuities also have little to no fees, making them an appealing option for conservative investors who want some market exposure.
Before committing, understand how returns are calculated – whether through annual point-to-point, monthly averaging, or high-water mark methods – and evaluate these options carefully.
2. Check All Fees and Costs
Annuity fees can eat into your returns, so it’s important to understand them upfront. For example, variable annuities can carry total fees exceeding 3% of your account value annually. Some contracts even layer multiple charges, which can add up significantly over time.
The cost of an annuity varies widely depending on the type. Here’s a quick look at typical commissions:
| Annuity Type | Commission (%) |
|---|---|
| Single-Premium Immediate Annuities (SPIAs) | 1% to 3% |
| Longevity Annuities (DIAs) | 2% to 4% |
| Fixed-Rate Annuities | 1% to 3% |
| Variable Annuities (VAs) | 4% to 7% |
| Fixed-Index Annuities (FIAs) | 6% to 8% |
In addition to commissions, you’ll face other costs. Administrative fees usually hover around 0.3% of the annuity’s value, while mortality and expense risk charges average 1% to 1.25% annually. Variable annuities also come with investment management fees ranging from 0.5% to 2%.
Let’s unpack some of these fees, starting with management costs.
Management Fees
Management fees cover the ongoing expenses of maintaining your annuity. These charges typically range from 0.10% to 0.50% annually. While that might seem small, over decades, these fees can significantly reduce your earnings.
Variable annuities tend to have higher management fees because they involve actively managed investment portfolios. Mortality and expense risk fees alone can cost 1% to 1.5% of your account balance annually. These fees cover administrative costs and guarantees provided by the annuity.
Optional riders, which offer additional benefits, come with their own costs. For instance, income riders on fixed-index annuities often range from 0.5% to 1.2% annually, and can sometimes go as high as 1.5%. Overall, rider fees typically fall between 0.25% and 1% of the contract value annually, depending on the benefits offered.
When comparing providers, look for transparency in their fee structures. Some bundle all costs into one charge, while others itemize each fee separately. Ask your advisor for a detailed breakdown of every cost and how it will impact your long-term returns.
Now, let’s dive into surrender charges, which affect your ability to access funds early.
Surrender Charges
Surrender charges are penalties for withdrawing money from your annuity before the agreed-upon period ends. These fees can be steep, reaching up to 10% of the funds contributed within the first year.
The surrender charge period usually lasts between three and 10 years, with most contracts falling in the six-to-eight-year range. Charges typically decrease over time. For example, a common surrender schedule might look like this:
- Year 1: 6%
- Year 2: 5%
- Year 3: 4%
- Year 4: 3%
- Year 5: 2%
- Year 6: 1%
- Year 7: No charge
Here’s how it works: If you withdrew $10,000 in the second year, with a 5% surrender charge, you’d lose $500 right off the top ($10,000 × 5%). That’s $500 less available for your needs.
Fortunately, many annuities include free withdrawal provisions, allowing you to access up to 10% of your funds annually without triggering a surrender charge. Some contracts also waive these penalties in specific cases, such as job loss, disability, or death.
Chris Coburn, Annuities Expert at MassMutual, notes: "The surrender charge is a deterrent against investors taking out money from an annuity and as such draws ire from time to time. That’s why it’s important to understand what surrender charges may apply to any annuity you may be considering".
To avoid these fees, only commit money to an annuity that you won’t need during the surrender charge period. It’s also wise to keep a separate emergency fund to cover unexpected expenses without dipping into your annuity.
3. Understand Tax Rules
Getting familiar with tax rules is a key step in making the most of your annuity. While the topic can feel complex, it’s something you’ll want to grasp early to avoid surprises down the road. One major advantage of annuities is their tax-deferred growth – taxes are only due when you make withdrawals. This deferral can boost your savings significantly over time, thanks to compounding. However, just like fees, taxes directly impact your net returns.
Qualified vs. Non-Qualified Annuities
How your annuity is taxed largely depends on whether it’s a qualified or non-qualified annuity. This distinction plays a big role in determining your tax obligations.
- Qualified Annuities: These are funded with pre-tax dollars, typically from accounts like 401(k)s or IRAs. When you withdraw funds, the entire amount is taxed as ordinary income. For 2024, contribution limits for 401(k) or 403(b) plans are set at $23,000, or $30,500 if you’re 50 or older.
- Non-Qualified Annuities: These are purchased with after-tax dollars, which means only the earnings on your withdrawals are taxed. Your original investment is returned to you tax-free.
Here’s a quick comparison of their key features:
| Feature | Qualified Annuities | Non-Qualified Annuities |
|---|---|---|
| Funding Source | Pre-tax dollars | After-tax dollars |
| Tax on Withdrawals | Entire amount taxed as income | Only earnings taxed; principal is tax-free |
| Contribution Limits | Subject to IRS limits | No IRS-imposed limits |
| Required Distributions | RMDs start at age 73 | No RMDs during your lifetime |
Early Withdrawals and Penalties
If you withdraw funds before age 59½, the IRS may impose a 10% penalty in addition to regular income taxes. This penalty generally applies first to the earnings portion of your withdrawal.
For example, consider a $100,000 annuity growing at 5% annually for 20 years. At the end of that period, it would grow to $265,330. If you withdraw the lump sum and are taxed at 32%, you’d net about $212,424. Compare this to a similar investment in a taxable account, which would yield approximately $149,765 after taxes.
Tax Rates: Annuities vs. Investments
One downside to annuities is that withdrawals are taxed as ordinary income, with rates potentially reaching up to 40.8% for some taxpayers (37% federal rate plus a 3.8% net investment income tax). In contrast, long-term capital gains from investments like index funds are taxed at a maximum rate of 23.8%.
Patrick L. Young, CPA and Executive Editor with Thomson Reuters Checkpoint, highlights the appeal of annuities:
"Investors are often drawn to fixed and variable commercial annuities because of the tax-deferred accumulation of earnings they offer. This deferral of tax makes annuities a valuable retirement savings vehicle for many investors, whether it be a supplement for those with other qualified plan benefits or a sole retirement arrangement for those without access to qualified plans".
Other Considerations
Before making withdrawals, it’s a good idea to consult financial and tax advisors. Your current tax bracket – and where you think it might be in the future – should help guide your choice between a qualified or non-qualified annuity. Additionally, some annuity contracts include a “free withdrawal” feature, allowing you to withdraw up to 10% of the contract value annually without surrender charges, though taxes may still apply .
While annuities offer tax advantages, the rules can be intricate and vary depending on your situation. Professional advice can help you maximize these benefits while steering clear of costly mistakes. Understanding these tax rules ensures your annuity fits seamlessly into your broader retirement plan.
4. Look at Inflation Protection
When planning for retirement, it’s important to think about how inflation might affect your income. Just like fees and taxes, inflation can significantly impact the value of your annuity over time. Inflation-adjusted annuities address this by increasing payments as costs rise, helping to maintain your purchasing power. For instance, the personal consumption expenditure (PCE) inflation rate was 2.7% in the first quarter of 2025.
Historically, inflation remained relatively steady between 1% and 2.3% until it spiked to 7% in 2021. More recently, it settled back to 2.3% in April 2025.
How Inflation Protection Works
Inflation-adjusted annuities often rely on the Consumer Price Index (CPI) to determine cost-of-living adjustments. If the CPI increases, your payments rise accordingly. Most contracts include safeguards, such as a minimum threshold to prevent drastic reductions if the CPI declines. Some even account for negative CPI changes to balance future increases, while also capping annual adjustments to manage costs.
However, there’s a trade-off. Choosing inflation protection typically lowers your initial payment compared to a standard annuity. This reduction can exceed 25%, and adding this feature may raise the premium by 20–30%.
The Cost of Protection
Inflation protection comes at a price. For example, the initial income from an inflation-protected annuity might be about 25% lower than a standard annuity. Over time, though, the payments adjust upward to combat rising costs.
To illustrate, here’s how $100,000 in various savings products might grow over five years:
| $100,000 Today in Savings Product | Value in 5 Years | Purchasing Power Change |
|---|---|---|
| Money Market Fund (0.46% growth) | $102,321 | $102,321 – 112,096 = $9,775 loss |
| 1-Year Certificate of Deposit (1.68% growth) | $108,687 | $108,687 – 112,096 = $3,409 loss |
| Fixed Indexed Annuity (9% cap) | $129,503 | $129,503 – 112,096 = $17,407 gain |
Types of Inflation Protection
To address inflation, annuities offer several cost-of-living adjustment (COLA) options. These can help you balance long-term income needs:
- Level Percentage Increases: Payments grow by a fixed percentage each year, typically between 1% and 6%, providing steady and predictable growth.
- CPI-Based COLA Riders: Adjustments are tied to changes in the Consumer Price Index, which better reflects actual inflation but can vary from year to year.
Expert Perspective
Aamir M. Chalisa, MBA, LUTCF, MDRT, and General Manager at Futurity First Insurance Group, highlights the importance of considering inflation when choosing an annuity:
"We all experience inflation throughout our lives, and annuity contracts are not exempt from this challenge. Many individuals worry that current interest rates and guaranteed income annuities may not keep pace with inflation rates, potentially impacting their retirement savings plans. This concern is valid, which is why there are annuity products designed to adjust for inflation. Opting for one of these products could be a wise decision, albeit at an additional cost."
Making the Decision
Whether an inflation-protected annuity is the right choice depends on future inflation trends. If inflation stays low, the added cost might not be worth it. But if inflation rises, the protection could be invaluable.
When evaluating a COLA rider, consider how it fits into your overall retirement income plan. Keep in mind that while Social Security includes COLA adjustments, private pensions usually do not.
Ultimately, the choice should reflect your financial situation, retirement goals, and comfort with risk. Speaking with a financial advisor can provide clarity on whether an inflation-protected annuity aligns with your retirement strategy.
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5. Check the Company’s Financial Strength
When you buy an annuity, you’re placing a lot of trust in the insurer’s ability to remain financially stable for the long haul. It’s crucial to evaluate their financial health and licensing to ensure your retirement funds are secure.
Check Financial Ratings
Independent agencies assess the financial stability of insurance companies by analyzing factors like profitability, debt levels, and cash reserves. These ratings help gauge whether a company can meet its obligations, including paying out your annuity benefits. The four major rating agencies – A.M. Best, Standard & Poor’s (S&P), Moody’s, and Fitch Ratings – use unique criteria, so their evaluations may differ. Among them, A.M. Best is highly regarded for its focus on the insurance industry and has been rating insurers since 1906.
Here’s a quick look at how the top agencies grade insurers:
| A.M. Best | Standard & Poor’s | Moody’s | Fitch |
|---|---|---|---|
| A++ (Superior) | AAA (Extremely Strong) | Aaa (Exceptional) | AAA (Exceptionally Strong) |
| A+ (Superior) | AA+ (Very Strong) | Aa1 (Excellent) | AA+ (Very Strong) |
| A (Excellent) | AA (Very Strong) | Aa2 (Excellent) | AA (Very Strong) |
| A- (Excellent) | AA- (Very Strong) | Aa3 (Excellent) | AA- (Very Strong) |
Don’t just take an insurance company’s word for it – verify their ratings directly on the agencies’ websites. It’s also wise to check ratings from multiple sources, as an A+ rating from A.M. Best doesn’t hold the same weight as an A+ from S&P. For example, A.M. Best’s A+ is their second-highest rating, while S&P’s A+ is ranked fifth. To ensure reliability, look for insurers with A.M. Best ratings of A‑ or higher and avoid those with S&P ratings below BB‑. If you want to dig deeper, consider the COMDEX score, which combines multiple ratings into a single percentile ranking. A COMDEX score above 90 signals a strong financial position. Keep in mind that ratings can change over time, so it’s a good idea to check them periodically.
For context, in January 2025, A.M. Best reported that State Farm Group topped all property and casualty insurers with $92.6 billion in net premiums written in 2023, maintaining an A++ (Superior) rating. Berkshire Hathaway followed with $77.2 billion in net premiums written and an A+ (Excellent) rating.
Confirm Licensing and Registration
Financial ratings are just one piece of the puzzle. You also need to confirm that the insurer and its agents are properly licensed. Start by visiting your state’s insurance department website or using tools like the NAIC SBS or NIPR. If you can’t find a company listed, contact your state’s insurance department directly to verify its status. While you’re at it, check for any complaints filed against the insurer on the NAIC website. These extra steps might take some time, but they’re worth it to protect your retirement savings.
6. Read Contract Terms and Guarantees
Your annuity contract is more than just paperwork – it’s a legally binding agreement that lays out the responsibilities of both you and the insurer. This document includes key details like penalties, benefits, and payment structures, so taking the time to review it thoroughly can save you from unwelcome surprises down the road.
Start by looking at the guaranteed interest rates. Fixed annuities should clearly specify the minimum interest rate you’ll receive throughout the contract’s duration. Be cautious of promotional rates that might seem attractive initially but drop significantly after a short period. Always insist on full transparency regarding the long-term rate you’ll actually earn.
Next, dig into the payout structure and any lifetime income guarantees. If you’re considering an income annuity, confirm the terms for lifetime payments. Ideally, the contract should promise steady monthly retirement checks that won’t dip below a certain amount, giving you peace of mind. For variable annuities, remember that payouts can fluctuate with market performance, so weigh the potential risks and rewards carefully.
Pay special attention to multi-tier contracts. These can significantly reduce your benefits if you opt for a lump-sum withdrawal instead of regular income payments. The contract should clearly outline any penalties for liquidating your annuity.
Also, review provisions for withdrawals, as well as spousal and beneficiary benefits. Make sure the contract allows access to emergency funds if needed and provides adequate protection for your loved ones in your absence.
It’s essential to understand the permanence of your decision. When you purchase an income annuity, the money you invest is typically locked in and returned to you as income payments. Annuitization is generally a one-way street, so make sure this aligns with your financial goals and long-term plans.
Be on the lookout for clauses that allow the insurer to adjust fees or rates. Some contracts permit changes based on factors like inflation, interest rates, or the financial health of the company. These adjustments can impact your future income, so it’s crucial to know exactly what you’re agreeing to.
Lastly, examine any optional riders included in the contract, such as those offering inflation protection or long-term care benefits. While these add-ons may increase your costs, they could provide extra security depending on your situation. Make sure you understand what each rider covers and how it might affect your overall returns.
7. Make Sure the Annuity Fits Your Plan
When considering an annuity, it’s crucial to ensure it aligns with your retirement goals and financial circumstances. Even if an annuity seems appealing, it might not be the right fit for your specific needs. Here’s how you can evaluate whether an annuity complements your overall retirement strategy.
Start by defining your retirement income goals. Break down your expenses into two categories: essential costs like housing, utilities, food, healthcare, and transportation, and discretionary spending for things like travel or hobbies. Many retirees plan to replace 70% to 100% of their pre-retirement income, which often means identifying additional income sources beyond Social Security benefits.
Next, balance your need for stability and growth. Your comfort level with risk and your investment preferences will play a big role here. As Certified Financial Planner Jose V. Sanchez puts it:
"Annuities are great fixed income vehicles…The right annuity in the right place is a very targeted tool for a portfolio."
Determine your "income gap" by calculating the difference between your essential living expenses and the income you expect from Social Security and pensions. This gap represents the amount you’ll need to cover with annuities or other savings. Steven J. Lee, Ph.D., a Finance Lecturer at Cal Poly Pomona, advises:
"Your annuity payout each month should equal your fixed retirement expenses…so you’re able to live somewhat comfortably and keep the lights on."
Consider your time horizon and liquidity needs. If you anticipate needing access to large sums of money for emergencies, be cautious about surrender charges and withdrawal limits. With the average 65-year-old living to around 85, your retirement income plan should be built to last at least 20 years.
It’s also important to evaluate how an annuity fits into your overall financial portfolio. An annuity should address gaps in your retirement income plan rather than overlap with existing sources like Social Security or pensions. For those with significant guaranteed income already, you may prioritize growth-oriented investments over additional annuity coverage.
Tax implications are another key factor. Annuities often come with specific tax advantages, particularly for individuals in higher tax brackets. However, keep in mind that annuity distributions are taxed as ordinary income, and withdrawals before age 59½ may incur a 10% penalty.
To make the best decision, consult a financial advisor. With 58% of Americans more likely to consider an annuity based on their advisor’s recommendation, scheduling a portfolio review can provide clarity on how different annuity options might meet your income needs.
Finally, ensure your annuity aligns with your long-term retirement strategy. Life changes – such as shifts in income, financial goals, or risk tolerance – can affect whether your annuity remains a good fit. Regularly reassess its role in your financial plan, especially after major milestones or adjustments in your circumstances.
Remember, the goal isn’t to find a "perfect" annuity. As Jose V. Sanchez wisely notes:
"There’s no one horrible annuity and no one perfect annuity – and that goes for just about every possible tool or product in the industry."
Instead, focus on choosing an annuity that addresses your retirement income needs while fitting comfortably within your overall financial plan and risk preferences.
Conclusion: Making a Smart Annuity Purchase
Buying an annuity means carefully weighing several crucial factors. This guide has walked you through the essentials – from different types of annuities and their costs to the importance of company reliability and contract details – so you can make a choice that fits seamlessly into your retirement strategy.
Annuities can be complex, and that’s why doing your homework is so important. Fees and commissions can eat into your long-term returns, so comparing options thoroughly is a step you can’t afford to skip.
It’s no surprise that annuities are becoming a more popular tool in retirement planning. On average, Social Security benefits replace only about 40% of a retiree’s income. This gap has led more Americans to explore annuities as a way to supplement their retirement income.
Before you finalize your decision, ask the right questions about fees, the financial health of the provider, and the product’s details. These questions can help uncover any conflicts of interest and ensure you’re receiving advice that’s in your best interest.
Make sure the annuity you’re considering fits your specific retirement needs. As Wade Pfau, a well-known retirement researcher, puts it:
"Risk pooling with an income annuity can support a higher level of lifetime spending compared to bonds."
That said, annuities aren’t a one-size-fits-all solution. For some, alternatives – like dividend-paying stocks, bonds, or a systematic withdrawal plan from a diversified portfolio – may be a better fit. A fee-only financial advisor, who is legally required to prioritize your best interests, can help you decide whether an annuity aligns with your goals or if other options might suit you better.
FAQs
What’s the difference between fixed, variable, and indexed annuities, and how do I choose the best one for my retirement needs?
Fixed annuities offer a guaranteed interest rate and consistent income, making them a solid option for cautious investors who value stability and want to avoid high risk. On the other hand, indexed annuities link their returns to a market index, giving you growth potential while ensuring your principal remains safe – perfect for those looking to balance security with moderate returns. If you’re comfortable navigating market ups and downs, variable annuities might appeal to you. They invest in market-based funds, offering greater growth opportunities but also carrying higher risk, making them a better fit for long-term investors aiming to keep pace with inflation.
When deciding which annuity suits you best, think about your risk tolerance, retirement income needs, and how long you’re planning to hold the investment. For instance, if you value steady, predictable income, a fixed annuity could be the right pick. But if you’re aiming for growth, an indexed or variable annuity might align better with your goals.
How do fees and surrender charges impact your annuity returns, and how can you reduce these costs?
Fees and surrender charges can take a noticeable bite out of your annuity returns, especially if you need to access your funds during the surrender period – usually lasting anywhere from 5 to 10 years. These charges, often calculated as a percentage of the amount withdrawn, are essentially penalties for early access to your money. The good news? They typically decrease over time.
To keep these costs in check, look for annuities with shorter surrender periods or even those that don’t have one at all. It’s also crucial to review the fee structure closely before committing. By understanding the terms upfront, you can make smarter decisions and avoid unwelcome surprises if you need to tap into your funds early.
What are the tax differences between qualified and non-qualified annuities, and how might they affect my retirement planning?
When you’re buying an annuity, understanding how taxes apply to qualified and non-qualified annuities is a key part of shaping your retirement plan.
- Qualified annuities are funded with pre-tax dollars, often from accounts like a 401(k) or traditional IRA. The money grows tax-deferred, but when you withdraw it, the entire amount is taxed as ordinary income.
- Non-qualified annuities, on the other hand, are funded with after-tax dollars. While you’ve already paid taxes on your contributions, the earnings grow tax-deferred. However, when you withdraw, only the earnings are taxed as income.
In essence, qualified annuities give you tax advantages upfront but result in taxable withdrawals later. Non-qualified annuities let your money grow tax-deferred, with taxes applying only to the earnings. Weigh your current tax bracket and future tax expectations to decide which option fits your financial plans.
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