The Pros and Cons of Buying an Annuity

Retirement planning eventually shifts from one big question, “How much can I save?” to another: “How will I turn those savings into reliable income?”

Annuities are one possible answer. They can provide predictable income, and some contracts can provide payments for life. But those guarantees come with trade-offs. Depending on the contract, you may face fees, surrender charges, limited access to your money, and terms that can be difficult to understand.

That is why understanding the pros and cons of buying an annuity matters before you move a large amount of retirement savings into one.

An annuity is neither automatically good nor automatically bad. The real question is whether the guarantees you’re buying solve a problem in your retirement plan and whether those benefits are worth the costs and loss of flexibility.

This guide explains how annuities work, their advantages and disadvantages, the so-called annuity age 75 rule, alternatives to consider, and the questions you should ask before buying one.

What Is an Annuity?

An annuity is a contract with an insurance company. You pay the insurer money, either as a lump sum or through contributions, and the contract can provide income immediately or at a later date.

Depending on the annuity, payments may continue:

For a set number of years
For your lifetime
For your life and your spouse’s life
Until another condition stated in the contract is met

The IRS describes an annuity as a series of regular payments made under a contract for more than one full year.

The key point is that an annuity is an insurance contract, not simply an investment account.

How Does an Annuity Work?

Although contracts vary considerably, an annuity can have two main stages.

1. Accumulation

During the accumulation period, your money may earn interest or investment returns depending on the type of annuity.

Growth within an annuity is generally tax-deferred, meaning taxes on earnings are typically postponed until distributions occur.

2. Distribution

The contract can later provide payments according to the option you selected.

Depending on the annuity, you might receive:

Monthly income
Quarterly payments
Annual payments
Payments for a certain number of years
Lifetime income

The exact terms matter. Two products both called “annuities” can work very differently.

What Are the Main Types of Annuities?

Before considering the pros and cons of buying an annuity, you need to know which type you’re evaluating.

Fixed Annuities

A fixed annuity generally credits interest according to rates established under the contract.

It may appeal to someone who values predictability more than higher potential investment growth.

Variable Annuities

A variable annuity allows money to be allocated among investment options, and the account value can rise or fall with their performance.

That creates greater growth potential but also greater investment risk. Variable annuities can also involve multiple layers of fees.

Fixed Indexed Annuities

A fixed indexed annuity bases credited interest partly on the performance of a market index, subject to the contract’s terms.

Importantly, owning an indexed annuity is not the same as directly investing in the underlying index.

Immediate Annuities

With an immediate annuity, you generally give an insurer a lump sum and begin receiving income relatively soon afterward.

Deferred Annuities

A deferred annuity is designed to begin providing income later.

This can give the money additional time to accumulate before distributions begin.

The Pros of Buying an Annuity

The competitor article correctly emphasizes regular income, tax deferral, guarantees on certain products, and customizable benefits as major potential advantages.

Let’s look at what those benefits mean in a retirement plan.

1. An Annuity Can Provide Lifetime Income

Perhaps the strongest argument for an annuity is protection against longevity risk: the possibility that you live much longer than expected and exhaust your savings.

Certain annuities can provide payments for life.

That can create an income floor alongside:

Social Security
Pensions
Retirement-account withdrawals
Other investments

For someone worried about running out of money, turning part of a portfolio into guaranteed lifetime income may provide valuable protection.

Remember, however, that insurance guarantees depend on the claims-paying ability of the issuing insurer.

2. Income Can Be More Predictable

Stock and bond markets fluctuate.

An annuity with contractual income guarantees can make part of your retirement income more predictable regardless of day-to-day market movements.

That may make budgeting easier for expenses such as:

Housing
Utilities
Groceries
Insurance
Healthcare

Predictability can become increasingly valuable as you move deeper into retirement.

3. Tax-Deferred Growth

Earnings inside an annuity generally grow tax-deferred until money is withdrawn.

That means you aren’t typically paying annual taxes on the contract’s gains while they remain inside the annuity.

However, “tax-deferred” does not mean “tax-free.” The taxation of distributions depends on how the contract was funded and other factors. The IRS has specific rules for determining the taxable and nontaxable portions of annuity payments.

4. Some Annuities Reduce Exposure to Market Losses

Certain fixed products provide contractual guarantees rather than direct stock-market exposure.

For retirees who are uncomfortable having all their retirement income depend on market performance, this can be useful.

However, reducing one type of risk often means accepting another trade-off, such as lower growth potential or reduced liquidity.

5. Annuities Can Help Simplify Retirement Income

Managing withdrawals from a large portfolio requires ongoing decisions.

You need to decide:

How much to withdraw
Which accounts to use
Which investments to sell
How to respond to market declines

An annuity can automate a portion of that income.

That doesn’t eliminate the need for financial planning, but it can simplify one part of the process.

The Cons of Buying an Annuity

The advantages can sound attractive, but they should never be considered without the other side of the contract.

Farm Bureau highlights fees, complexity, and penalties for accessing money early among the major drawbacks.

1. Your Money May Become Less Accessible

Liquidity is one of the biggest concerns.

Once money enters certain annuity contracts, withdrawing large amounts during the surrender period can trigger charges.

That can become a problem if you suddenly need money for:

Healthcare
Home repairs
Family emergencies
Long-term care
A major purchase

You should generally avoid putting money into a long-term contract if you may need that money soon.

2. Annuities Can Have Fees and Commissions

Depending on the product, costs can include:

Surrender charges
Administrative expenses
Mortality and expense charges
Investment expenses
Rider costs
Sales commissions

Not every annuity has every fee.

That’s why asking for a clear breakdown of all costs is important before signing a contract.

3. Annuities Can Be Complicated

One of the challenges with annuities is that the word covers many different products.

A simple immediate income annuity is very different from a variable annuity with multiple riders.

Contract terms can include:

Participation rates
Caps
Surrender periods
Income bases
Death benefits
Withdrawal limits
Rider provisions

If you cannot clearly explain how the product works, what it costs, when you can access your money, and what happens when you die, you probably need more information before purchasing it.

4. You May Give Up Growth Potential

Guarantees have economic value, and insurers do not provide them for free.

Depending on the annuity, accepting greater income certainty may mean giving up some investment flexibility or upside.

Someone with enough guaranteed income from Social Security and a pension may value growth and liquidity more than another income guarantee.

5. Inflation Can Reduce Purchasing Power

A fixed monthly payment may feel comfortable today but buy considerably less 15 or 20 years from now.

For example, if your annuity provides $3,000 per month for life but does not increase with inflation, the purchasing power of that $3,000 can gradually decline.

Some contracts provide inflation-related features, but these can affect initial payments or costs.

6. Tax Treatment May Not Always Be as Attractive as It Sounds

Tax deferral is useful, but taxes still matter.

The IRS explains that the taxable and tax-free portions of annuity payments depend on the contract and how it was funded.

Retirees should evaluate annuities as part of their broader tax strategy rather than focusing only on the phrase “tax-deferred.”

Pros and Cons of Buying an Annuity at a Glance

Potential Advantages	Potential Disadvantages
Lifetime income options	Limited liquidity
Predictable retirement income	Surrender charges may apply
Tax-deferred growth	Some products have significant fees
Protection from certain market risks	Contracts can be complicated
Can reduce longevity risk	May limit growth potential
Different payout options	Inflation can reduce purchasing power
Can supplement Social Security	Tax treatment can be complex

The important question isn’t which column is longer. It is which factors matter most to your retirement.

What Is Better Than an Annuity for Retirement?

People frequently ask what is better than an annuity for retirement, but there isn’t one investment that is universally better.

An annuity solves specific problems, particularly longevity risk and predictable income.

Other strategies solve different problems.

Possible alternatives include:

Bonds and Bond Ladders

A bond ladder can provide scheduled income while allowing you to retain ownership of the underlying investments.

CDs

Certificates of deposit can provide predictable interest and FDIC insurance within applicable limits, although returns and liquidity vary.

Retirement Accounts

IRAs and 401(k)s offer broader investment flexibility and may hold stocks, bonds, funds, and other assets.

Systematic Portfolio Withdrawals

Instead of buying an annuity, you can maintain an investment portfolio and withdraw a planned percentage each year.

This provides greater flexibility but leaves you responsible for investment and longevity risk.

Some retirees use the 4% rule for retirement as an initial framework for thinking about portfolio withdrawals, although no withdrawal percentage can guarantee that a portfolio will last indefinitely.

Social Security

Delaying Social Security can increase monthly benefits up to age 70 for eligible retirees. For some households, evaluating Social Security timing may be an important step before purchasing additional guaranteed income.

The best solution may also be a combination rather than choosing one product.

Annuity vs. 4% Withdrawal Strategy

Consider a retiree with $1 million.

One approach could be to maintain the portfolio and follow a planned withdrawal strategy.

Another could be to use part of the $1 million to purchase guaranteed income while keeping the remainder invested and accessible.

The second approach creates two separate buckets:

Income bucket: Helps cover essential expenses.

Investment bucket: Provides liquidity and potential long-term growth.

This is why annuity decisions should be made as part of an overall retirement-income plan rather than in isolation.

What Is the Annuity Age 75 Rule?

The phrase annuity age 75 rule can be misleading.

There is no general U.S. law saying everyone must purchase an annuity at 75 or that age 75 is automatically the best time to buy one. Farm Bureau specifically describes the idea that 75 is universally the best age to purchase an annuity as a myth. Insurers may also establish their own age limits for particular contracts.

Age 75 can appear in other retirement rules. For example, SECURE 2.0 raises the required minimum distribution age to 75 for people born in 1960 or later. That is an RMD rule for applicable retirement accounts, not a universal rule requiring someone to purchase an annuity at age 75.

Your age can still affect annuity pricing and payouts because life expectancy is one of the factors insurers use. But age alone should not determine whether an annuity belongs in your retirement plan.

When Can You Withdraw Money From an Annuity?

This depends on the contract.

Two different issues may apply:

The insurer’s surrender charges
Federal tax rules

The IRS generally imposes a 10% additional tax on the taxable portion of certain early distributions from deferred annuity contracts before age 59½, unless an exception applies.

Your contract may have separate surrender charges.

Always check both before withdrawing money.

Who Might Benefit From an Annuity?

An annuity may be worth considering if you:

Want predictable lifetime income
Are concerned about outliving your savings
Have already built adequate emergency reserves
Want part of your income protected from market fluctuations
Understand the contract and its costs
Have enough liquid assets outside the annuity

Someone wondering how long will $3 million last in retirement? may have a very different need for guaranteed income than someone entering retirement with $500,000 and no pension.

The decision should be based on the entire retirement plan.

Who May Not Need an Annuity?

An annuity may be less attractive if you:

Need easy access to your money
Already have substantial guaranteed pension income
Want maximum investment flexibility
Have a short time horizon
Don’t understand the contract
Would have to put most of your liquid savings into the annuity

You should be especially careful if buying an annuity would leave you without adequate emergency savings.

How Do Housing Costs Affect the Decision?

Guaranteed retirement income should be compared against your essential expenses.

Housing is often one of the largest.

Before allocating a large lump sum to an annuity, consider whether you should pay off your mortgage before retirement and how either decision would change your monthly cash flow.

For example, using $200,000 to purchase an annuity and using $200,000 to eliminate a mortgage can produce very different financial outcomes.

Neither option is automatically correct.

What About Early Retirement?

Annuities should also be considered alongside your retirement age and access to other accounts.

Someone retiring in their mid-50s may have different liquidity needs than someone buying an immediate annuity at 70.

Understanding the rule of 55 for early retirement can be particularly useful for certain people leaving an employer during or after the year they turn 55 because it may provide penalty-free access to eligible employer-plan assets under specific conditions.

The more years your retirement must cover, the more important liquidity and income planning become.

Annuities After the Loss of a Spouse

Widows and widowers should be particularly careful about making major financial decisions shortly after losing a spouse.

You may be dealing with changes involving:

Social Security survivor benefits
Pensions
Life insurance
Retirement accounts
Housing
Taxes
Estate assets

An annuity may eventually make sense, but it should be considered alongside the rest of your financial situation.

Our guide to financial advice for widows explains several of the financial decisions that can arise after losing a spouse.

Questions to Ask Before Buying an Annuity

Don’t make the decision based only on the advertised income amount.

Ask:

What type of annuity is this?
What problem does it solve in my retirement plan?
What guarantees does it provide?
Who guarantees those benefits?
What are all the fees and commissions?
How long is the surrender period?
How much can I withdraw without a surrender charge?
Does the income increase with inflation?
What happens to the remaining value when I die?
What does my spouse receive?
How will distributions be taxed?
What am I giving up by putting this money into an annuity?
What alternatives have I compared it with?
How is the person recommending the annuity compensated?

If the answers aren’t clear, don’t rush the decision.

Should You Talk to a Financial Advisor Before Buying an Annuity?

Annuity contracts can be difficult to compare because guarantees, riders, surrender periods, costs, and payout structures differ from product to product.

A financial advisor in Richmond can help you look beyond the product itself and determine how an annuity would affect your retirement income, taxes, investments, estate plan, and available cash.

The objective should be to determine whether the product improves your financial plan, not simply whether the annuity has attractive features.

How Just A Conversation Can Help

At Just A Conversation, Brian Hennaman, Certified Financial Planner™, helps individuals and families evaluate retirement decisions based on their complete financial picture.

That may include retirement income, Social Security, investments, taxes, housing, and decisions about products such as annuities.

A good retirement plan isn’t built around one financial product. It’s built around what you need your money to accomplish.

Final Thoughts

Understanding the pros and cons of buying an annuity is important because you’re often making a long-term decision with money that took decades to accumulate.

An annuity’s greatest strength is also the reason it requires careful consideration: you can exchange some flexibility for greater certainty.

For retirees worried about outliving their savings, guaranteed lifetime income may be valuable. For people who prioritize liquidity, investment growth, and control, other approaches may be more appropriate.

Before purchasing an annuity, understand exactly what you’re buying, what you’re paying, what you’re giving up, and how the contract fits into the rest of your retirement plan.

FAQs

What is the biggest drawback to annuities?

One of the biggest drawbacks is limited liquidity. Many annuity contracts include surrender periods during which withdrawing more than an allowed amount can trigger charges. Some products can also have substantial fees and complicated terms.

How much will a $100,000 annuity pay monthly?

There is no single monthly payout for a $100,000 annuity. The amount depends on your age, sex where permitted in pricing, interest rates, annuity type, when payments begin, whether payments cover one or two lives, and whether you select features such as a refund or guaranteed period.

The only reliable way to know is to obtain current quotes for the specific contract and payout option you’re considering.

What does Warren Buffett say about annuities?

Be careful with claims online that attribute a simple “annuities are good” or “annuities are bad” quote to Warren Buffett. Berkshire Hathaway operates insurance businesses and has had exposure to annuity-related products, but that does not establish a blanket personal recommendation from Buffett that retirees should buy annuities.

Your decision should be based on the contract and your retirement needs rather than a celebrity investor’s name.

What does Dave Ramsey say about annuities?

Dave Ramsey and Ramsey Solutions generally recommend against annuities. Ramsey Solutions argues that fees, surrender charges, complexity, limited access to money, and other trade-offs make them less attractive than its preferred investment approach.

That is one viewpoint, not a rule that applies to every retiree. Annuities can provide lifetime income and transfer some longevity risk to an insurance company, so whether one makes sense depends on the individual retirement plan.