Purchasing an Annuity

How Do I Buy an Annuity?

After you’ve chosen your annuity provider and decided the terms of the contract, you’re ready to buy. But what’s the process for buying an annuity?

“I think the process is twofold,” says Certified Financial Planner™ professional Marguerita M. Cheng. “Are you purchasing an annuity with retirement funds, such as an IRA? If that’s the case, it would be a custodial transfer and a non-taxable event. With non-retirement money, if it’s cash in your checking account, you can write a check. If it’s cash in your brokerage account, you could initiate a transfer.”

Annuities are primarily used as retirement income-generating vehicles. Tax-deferred growth is an added benefit for those who invest earlier than the date they require income withdrawals. Before choosing an annuity, consult with a licensed advisor who can offer you unbiased recommendations for your own retirement income situation. Annuities can (but not always) have high fees. For those that need guaranteed income in the future, they can provide much-needed peace of mind.

— Stephen Kates, CFP®

When you’re considering purchasing an annuity, it’s important to choose a reputable and stable provider. One way to research annuity providers is to refer to financial rating agencies like Moody’s and S&P Global for recent ratings. Because the federal government does not back annuities, it’s important that you choose a reputable, stable carrier. Typically, annuities are purchased through an insurance company, but you can also buy them from brokerage firms, mutual fund companies, and banks.

“If you have investments you need to sell to fund the account, please consult with your tax advisor regarding the tax implications,” Cheng advises. “You don’t want to invest all the proceeds.”

You should also be aware of state premium taxes that may affect you.

When Should I Purchase an Annuity?

In short, the best age to buy an annuity is when it meets your needs. That differs from person to person, so you should have a good handle on your investment goals and the best ways to meet them.

So, the first step is to look at your financial situation and goals, and given all that, consider whether you should buy an annuity.

For example, if you’ve maxed out your contributions to other tax-advantaged retirement accounts and you would like to set aside more money for retirement, you might consider purchasing an annuity.

Interest rates also play a role in purchasing an annuity. The best time to lock in your contract is when interest rates are high. If they’re low, you may want to wait. Or you could consider laddering — a strategy that allows you to take advantage of fluctuating conditions by purchasing more than one annuity at different points in time.

The earlier you buy a deferred annuity, the more time it will have to grow. A deferred annuity is an annuity in which the payout begins at a later point in time, typically after retirement. The longer you put off receiving the income stream, the higher the payments will be.

If you’re close to retirement or are retired and looking for a way to turn your savings into a stream of income, an immediate annuity might be the right option for you.

“When you make a decision to purchase an annuity, you are giving up access, or liquidity, in exchange for guarantees,” says Cheng. “That’s the first consideration. How much of my resources am I okay with not being able to access immediately?”

“Next, you can think about how soon you need the money. This involves deciding if you want a deferred or immediate annuity. Finally, do you value stability and predictability? That can help you determine if fixed or appropriate is right for you.”

How Will Purchasing an Annuity Affect my Retirement Plan?

The guaranteed income stream provided by many annuities gives retirees peace of mind by ensuring their needs will be provided for as they traverse their golden years. Employer-provided pensions are quickly becoming extinct, leaving many retirees to live on Social Security and their savings.

But Social Security replaces only a small amount of pre-retirement income. And it may be a challenge to determine how to spend your savings comfortably in retirement while not depleting them entirely due to uncertainty in your life expectancy.

That’s where annuities come in and provide “longevity insurance” by insuring against outliving your savings. You can also purchase a joint annuity with your spouse, so you both receive the payments for your entire lives.

Annuities can also address strategic needs in your retirement portfolio. For example, a qualified longevity annuity contract (QLAC) is purchased inside a qualified retirement account. Up to certain limits, the money used to purchase a QLAC is exempt from your required minimum distribution (RMD).

An RMD is the amount of money the IRS requires you to withdraw from your tax-advantaged savings accounts every year once you hit 73 or 72 years of age, depending on the year you were born. For some people, this can be problematic because it affects taxation and Medicare costs. QLACs can effectively solve that problem.

What Are the Advantages and Disadvantages of Buying an Annuity?

Annuities come in many varieties, each with its own advantages and disadvantages. Typically, the simpler and more straightforward the annuity, the less expensive it is. But it’s impossible to give a definitive list of the pros and cons of annuities across the board since it varies based on one’s preferences.

The one main reason to buy an annuity is the tax treatment. Annuity premiums — the purchase price of your contract — grow tax-deferred until you receive payments.

On the other hand, most annuities have the disadvantage of locking up your principal investment for several years, unless you decide to sell your annuity payments at a discount to a company called a factoring company. This may be an option if you have an urgent need for cash.

One additional disadvantage that has become relevant is the potential impact of inflation. Some types of annuities could be affected by inflation due to their reduced spending power. And according to the U.S. Bureau of Labor Statistics, consumer prices were up 5% from March 2022 to March 2023.

Your best course of action is to research different types of annuities to get a complete understanding of the advantages and disadvantages of each.

How Do I Choose the Best Annuity for Me?

“The decision to purchase an annuity is very personal,” says Cheng. “Every investor’s financial situation is unique.”

That’s why it’s best to determine your needs and goals and evaluate your comfort level with risk.

Questions To Ask Yourself Before Choosing an Annuity

• Are you looking for guaranteed income or long-term growth?
• How close are you to retirement?
• What other income streams do you have in place?
• Are you prepared for lifestyle changes that come with retirement and the loss of a steady income?
• Does your family have a history of longevity and are you in good health?

For example, if you want a reliable income for life with little risk and low costs, you might consider a fixed annuity. If you’re comfortable taking some risks in exchange for the possibility of higher returns, a variable annuity might suit you.

Likewise, consider riders — such as long-term care insurance — to tailor the contract to your needs. If you want to provide for your loved ones after you’re gone, consider getting a rider that includes the ability to designate beneficiaries.

Because annuities — and finances in general — can be complicated, it’s important to talk to a professional who can help you evaluate your retirement portfolio and explain your financial options.

Take your time. Make sure you understand all the provisions of your annuity contract, including the fees and commissions. Get more than one quote so you can compare the offerings of different insurance companies.

Finally, confirm that the company you’re considering has a good reputation, complies with annuity regulations and is financially sound.

One good way to vet the companies is to look into their standings with rating agencies, including AM Best, Moody’s and Fitch.

Who Are Annuities Best For?

Since annuities are so customizable and come in different forms, there isn’t one type of person that they are best for. They can be shaped to benefit many different people.

Whether you are looking to convert a nest egg into a stream of payments right now or are planning to grow value over years, an annuity can help.

There are several groups that may find annuities particularly effective.

Types of People Who Can Benefit from Annuities

High-Net-Worth Individuals

Annuities are an excellent way to grow existing wealth or convert it into guaranteed income, making them an attractive option to include in the portfolio of a high-net-worth individual.

Retirees

The ability to guarantee income for life is very attractive to retirees, helping ensure they will never have to worry about outliving their savings.

Small-Business Owners

Those who are self-employed or own small businesses don’t always have traditional savings options available to them. Annuities can help guarantee their financial security over other savings strategies.

U.S. Expats

Living or working overseas can mean that not all savings methods available in the country are tenable. But annuities can be used to grow or guarantee income when living in another country.

Women

Women are less represented in the workforce than men and can benefit from annuities as an innovative way to grow their wealth and help bridge the financial gap.

Trust-Owned Annuities

One unique way to leave money to beneficiaries can be to place an annuity within a trust, which can have certain tax advantages.

Buying an Annuity for Your Child

Annuities can be used to guarantee income for your beneficiaries. Purchasing an annuity for your child can help stretch out their inheritance over many years.

These are far from the only groups who can benefit from annuities. Their customizability makes them attractive to many Americans looking for ways to invest their money.

Scenarios When You Should Not Buy an Annuity

Above all, you should not buy an annuity if you are not sure that you can afford it. Annuities are typically long-term contracts that you often cannot break once they’re activated.

Say you invest your entire nest egg into an annuity and, several months later, run into a financial crisis. There may be no way to take all that money out of the annuity to deal with the crisis.

Even if you can get the money back by giving up the annuity, there may be significant surrender charges.

Other people who probably don’t need to consider an annuity are those that don’t need any additional or guaranteed income in retirement. You may find that your existing savings, 401(k) or other plan covers your retirement needs, especially when paired with Social Security.

If this is the case, it may simply not make sense to devote a significant chunk of your savings to an annuity.

Where Can I Buy an Annuity?

There are numerous annuity companies and providers that you can purchase an annuity through. These options range from banks to insurance companies.

Some annuities can be purchased simply by visiting a website. You may be able to go through the whole process online, especially if you are not purchasing a particularly complex option.

Many insurance agencies also offer annuities, meaning you can reach out to them to learn more about their options and work with them to customize the annuity that makes the most sense for you.

If you’re looking to purchase an annuity from a company with strong financial security, banks also often sell annuities. Remember though, just because a bank sells you an annuity does not necessarily mean that the same legal protections and assurances to your other assets like a savings account applies.

Annuities can also be purchased from investment firms as well, offering you another way to secure and construct an annuity that makes sense for you.

It’s important to note that the federal government does not insure your annuity, so it is critical to be certain that you are dealing with a strong and legitimate provider.

How Will I Fund an Annuity?

There are several paths to funding an annuity, depending on the type and style that you are looking for.

The stage of life you are in will also make a big difference.

Say that you are nearing retirement and are looking to convert an existing nest egg into a guaranteed stream of payments. The funds for your annuity are readily available, which is the portion of your existing savings you want to convert into payments.

If you are younger and are interested in annuities because you have hit the cap on what you can contribute to your other retirement accounts, then funding an annuity would come directly from your income.

Contributing to an annuity can work similarly to contributing to other accounts, with you regularly setting aside part of your income to continue growing the annuity.

You also may be able to fund an annuity in some circumstances by converting the existing money that you have in an account like a 401(k) or IRA.

Frequently Asked Questions About Annuities