When to Buy an Annuity: Questions to Ask Before You Commit

Quick overview

An annuity turns money into a stream of income. Whether it’s a good buy now, later, or never depends on trade-offs: guaranteed income vs liquidity, insurer credit risk vs potential market returns, fees vs payout guarantees, and tax timing. In my 15 years advising retirement clients, timing decisions often hinge less on age and more on cash-flow needs, other guaranteed income sources (Social Security, pensions), and flexibility requirements.

How annuities work in plain terms

• You pay a premium now (single premium) or over time (flexible premium).
• The insurer invests and guarantees a payout schedule in return. Payouts can start immediately (immediate annuity) or at a future date (deferred annuity).
• Payouts vary by type: fixed (set amount), variable (linked to investment performance), indexed (tied to an index with caps/floors), or hybrids with riders (e.g., guaranteed lifetime withdrawal benefit).

For authoritative background on tax and contract rules see IRS Publication 575 (Pensions and Annuities) and FINRA’s annuity resources (IRS Pub 575: https://www.irs.gov/publications/p575; FINRA: https://www.finra.org).

When timing matters most

Consider these common timing scenarios and why the decision matters:

• Near retirement (age 60s): Buying an immediate annuity can convert a portion of savings to guaranteed income to cover essentials. This provides predictability but reduces liquidity.

• Early retirement or still accumulating: Deferred annuities can offer tax-deferred growth, but high fees or surrender periods may make them less attractive than IRAs or employer plans.

• When you need longevity protection: If you fear outliving savings, buying a lifetime income annuity (or using techniques like laddering or a Qualified Longevity Annuity Contract) later in life can lock in higher payout rates because payouts increase with age.

• To manage Required Minimum Distributions (RMDs) or reduce sequence-of-returns risk: Certain products (like QLACs) can postpone RMDs on some retirement accounts; see our guide on Qualified Longevity Annuity Contracts (QLAC).

Key questions to ask before you commit

Ask every insurer, agent, or advisor these specifics and get written answers in the contract illustration:

1. What type of annuity is this and how are payouts calculated? (fixed, variable, indexed, immediate, deferred)
2. What fees and charges apply? Include premium loads, mortality & expense (M&E) fees, administrative fees, sub-account fees, and rider costs.
3. What is the surrender charge schedule and length? For details, compare the product illustration and our article on Annuity Surrender Charge.
4. How does the product handle inflation? Are there cost-of-living adjustments or inflation-indexed payout options?
5. What guarantees are backed by the insurer versus the state guaranty association? What are state limits?
6. What death benefits exist for beneficiaries and how are they taxed?
7. If it’s a variable or indexed annuity, what are the caps, participation rates, spreads, and crediting methods?
8. If you plan to annuitize later, what assumptions does the illustration use for future payout rates?
9. Are there riders (e.g., guaranteed lifetime withdrawal benefit, spousal continuation) and what do they cost?
10. Can I change my mind? What are the free-look and surrender provisions?

Keep answers and illustrations; compare multiple competing quotes before deciding.

Pros and cons to weigh

Pros:

• Predictable income stream that can replace some market risk.
• Certain riders provide guaranteed income for life.
• Tax deferral inside the contract (earnings aren’t taxed until withdrawn) for nonqualified annuities.

Cons:

• Potentially high fees that reduce effective returns (see FINRA guidance on costs).
• Limited liquidity and surrender charges in early years.
• Credit risk: annuity guarantees depend on the insurer’s claims-paying ability; state guaranty associations have limits and rules.
• Complex product structures (especially indexed and variable annuities) that are hard to compare.

Tax and regulatory points to remember

• Nonqualified annuities (purchased with after-tax dollars) grow tax-deferred; earnings are taxed as ordinary income when withdrawn. IRS Publication 575 explains annuity taxation and distribution rules (https://www.irs.gov/publications/p575).
• Withdrawals before age 59½ may face a 10% additional tax penalty on the taxable portion, with certain exceptions (IRS rules).
• If you annuitize, the contract’s exclusion ratio determines the tax-free portion vs taxable earnings for each payment; if you withdraw before annuitization, distributions often follow LIFO (earnings first).
• Qualified annuities held inside an IRA or 401(k) follow retirement account rules: distributions are generally taxed as ordinary income and subject to RMD rules unless an exception applies.

Because tax rules change and individual circumstances differ, consult a tax professional before acting.

How to evaluate the insurer and product quality

• Check financial-strength ratings from AM Best, Moody’s, or S&P; higher-rated companies are more likely to meet long-term guarantees.
• Review the insurer’s annual statement and be wary if sales rely heavily on complex riders.
• Confirm state guaranty association protection and limits for where you live.
• Ask for and compare contract illustrations from multiple carriers; small differences in payout rates or fees can add up materially.

Alternatives and hybrid approaches

An annuity isn’t the only way to generate retirement income. Consider:

• Building a bond/TIPS ladder to provide predictable cash flows while keeping principal liquid.
• Systematic withdrawal strategies from a diversified portfolio with a sustainable withdrawal rate.
• Partial annuitization: buy an annuity to cover essential needs and keep the rest invested for growth.
• Using bucket strategies or annuity laddering to combine liquidity and longevity protection; see our article on Annuity Laddering.

Practical examples (illustrative only)

• Single immediate annuity: A 65-year-old purchases a single-premium immediate annuity with $100,000 to cover housing and health expenses—trading liquidity for guaranteed monthly income.
• Deferred annuity for longevity: A 60-year-old buys a deferred annuity that starts payouts at 80 or 85 to ensure income if they live very long. This can be a strategy to hedge longevity risk.

Numbers above are illustrative. Actual rates vary widely by age, sex, prevailing interest rates, and insurer.

Red flags to avoid

• Overly aggressive sales tactics or pressure to sign quickly.
• Vague or missing details on fees, rider costs, or surrender charges.
• Promises that sound too good to be true — guaranteed returns that don’t align with market conditions or insurer financials.
• Complex bonus offers that increase early surrender penalties.

Step-by-step buying checklist

1. Identify the income gap you need to fill (essentials vs discretionary).
2. Compare annuities against alternative strategies (bonds, laddering, systematic withdrawals).
3. Get multiple written illustrations and compare net payouts after fees and rider costs.
4. Check insurer ratings and state guaranty protections.
5. Confirm tax implications with a CPA or tax advisor.
6. Read the contract carefully and note free-look and surrender periods.
7. Decide exact purchase timing—immediate income vs deferred and potential impact on RMDs.

Where to learn more and authoritative sources

• IRS Publication 575, Pensions and Annuities: https://www.irs.gov/publications/p575
• FINRA investor guidance: https://www.finra.org/investors/learn-to-invest/types-investments/annuities
• Consumer Financial Protection Bureau annuity resources: https://www.consumerfinance.gov/

Final thoughts and professional advice

Timing an annuity purchase is about matching product features to your personal liabilities, other guaranteed income, tax situation, and tolerance for illiquidity. In my practice, the best outcomes often come from partial annuitization—covering essential costs with guaranteed income while keeping a growth portion invested to handle inflation and unexpected needs.

This article is educational and not personalized financial advice. Consult a qualified, fee-only financial planner or tax professional who can model your retirement cash flows and show how an annuity would change your overall plan.