Comparing Annuities: Key Factors for Making the Right Choice

Quick answer

• Understand your financial goals and time horizon before considering an annuity.
• Evaluate different annuity types (fixed, variable, indexed) to see which aligns with your risk tolerance and income needs.
• Scrutinize fees, surrender charges, and rider costs, as they can significantly impact your returns.
• Compare the guaranteed income benefits and death benefit provisions offered by various contracts.
• Assess the financial strength and reputation of the insurance company issuing the annuity.
• Read the contract fine print carefully to avoid surprises about limitations or exclusions.

Who this is for

• Individuals seeking a guaranteed stream of income for retirement.
• Those looking for tax-deferred growth on their investments.
• People who want to protect a portion of their principal while potentially earning market-linked returns.

What to check first (before you act)

Goal and timeline

Before comparing any annuity, define precisely what you want this investment to achieve. Are you looking for immediate income, or do you need it to grow for several years before payout? Your time horizon is crucial; annuities are typically long-term commitments.

Current cash flow

Understand your current income and expenses. How much can you afford to invest? Will the annuity income supplement existing retirement income, or will it be your primary source? This helps determine the size of annuity you might need.

Emergency fund or safety buffer

Ensure you have a robust emergency fund before considering long-term, less liquid investments like annuities. Annuities are not designed for short-term access to funds. Check the official source or your provider for details on liquidity.

Debt and interest rates

Consider any outstanding high-interest debt. Paying down debt with high interest rates often provides a more guaranteed return than many annuity options. Evaluate the interest rates on your debts and compare them to potential annuity returns.

Credit impact

Annuities are insurance contracts, not typically credit products. Purchasing an annuity generally does not directly impact your credit score, but the financial health of the issuing company is paramount.

Step-by-step (how to compare annuities)

1. Define your primary objective: What is the main reason you are considering an annuity? Is it for guaranteed income, tax deferral, or wealth transfer?

• What “good” looks like: You can clearly articulate your main goal, such as “I need a reliable income stream for 20 years after I retire.”
• Common mistake: Not having a clear objective, leading to choosing an annuity that doesn’t meet your needs.
• How to avoid it: Write down your top 1-2 financial goals related to retirement income.

2. Determine your risk tolerance and time horizon: Are you comfortable with market fluctuations (variable/indexed annuities) or do you prefer a predictable, fixed return (fixed annuities)? How long do you plan to keep the money invested?

• What “good” looks like: You have a realistic understanding of how much risk you can handle and how long you can commit your funds.
• Common mistake: Choosing a complex product like a variable annuity without understanding market risk, or a fixed annuity that offers too little growth for a long time horizon.
• How to avoid it: Honestly assess your comfort level with potential losses and your expected investment period.

3. Identify suitable annuity types: Based on your objective and risk tolerance, narrow down the choices to fixed, variable, or indexed annuities.

• What “good” looks like: You’ve identified 1-2 annuity types that seem to fit your profile.
• Common mistake: Overlooking a suitable type due to a lack of understanding or being swayed by overly complex options.
• How to avoid it: Research the basic characteristics of each annuity type before diving into specific products.

4. Research reputable insurance companies: Look for companies with strong financial ratings from independent agencies.

• What “good” looks like: You have a shortlist of 2-3 highly-rated insurance companies.
• Common mistake: Choosing an annuity solely based on its features without considering the financial stability of the issuer.
• How to avoid it: Check ratings from agencies like A.M. Best, Moody’s, or S&P.

5. Gather product proposals: Obtain detailed illustrations and prospectuses for annuities from your chosen companies that match your selected type.

• What “good” looks like: You have several detailed proposals to compare side-by-side.
• Common mistake: Relying on verbal explanations or simplified marketing materials instead of the official contract documents.
• How to avoid it: Request and carefully review the official prospectus and contract for each annuity.

6. Compare fees and charges: Examine all associated costs, including mortality and expense charges, administrative fees, surrender charges, and rider fees.

• What “good” looks like: You can clearly see the total annual cost of each annuity as a percentage of your investment.
• Common mistake: Underestimating the impact of fees, which can erode returns significantly over time.
• How to avoid it: Create a spreadsheet to list and sum up all fees for each annuity.

7. Evaluate income benefit features (if applicable): If income is your goal, compare the guaranteed withdrawal amounts, payout options, and inflation adjustments.

• What “good” looks like: You understand how much guaranteed income you will receive and for how long under different scenarios.
• Common mistake: Assuming all income guarantees are the same; variations in calculation methods can lead to different payouts.
• How to avoid it: Ask for specific examples of income payouts based on your investment amount and desired payout start date.

8. Analyze surrender charges and liquidity: Understand the penalties for withdrawing money before the surrender period ends.

• What “good” looks like: You know exactly how much you would lose if you needed to access your funds early.
• Common mistake: Not realizing how long surrender periods can last or how steep the charges are.
• How to avoid it: Note the length of the surrender period and the percentage charged for early withdrawal in each year.

9. Review death benefit provisions: Understand what happens to the remaining contract value upon your death.

• What “good” looks like: You know if beneficiaries will receive the contract value, the original investment, or a stepped-up value.
• Common mistake: Assuming the full contract value goes to beneficiaries without considering any limitations or optional riders.
• How to avoid it: Clarify the death benefit options and their associated costs.

10. Consider riders and optional benefits: Compare any additional features you might want, such as guaranteed minimum withdrawal benefits (GMWBs) or long-term care riders, and their costs.

• What “good” looks like: You’ve decided which, if any, riders are essential and understand their value and cost.
• Common mistake: Adding too many riders, increasing complexity and costs unnecessarily.
• How to avoid it: Only select riders that directly address a critical need you cannot meet otherwise.

11. Consult a trusted financial advisor: Discuss your options with a fee-only financial planner who can offer unbiased advice.

• What “good” looks like: You have a clear recommendation from a professional who understands your situation and has no sales incentive.
• Common mistake: Relying solely on advice from an annuity salesperson who may be compensated based on sales.
• How to avoid it: Seek advice from fiduciaries who are legally obligated to act in your best interest.

Common mistakes (and what happens if you ignore them)

Mistake	What it causes	Fix
Not defining clear goals	Purchasing an annuity that doesn’t meet your income needs, growth expectations, or risk tolerance.	Clearly write down your primary financial objective (e.g., guaranteed income, tax deferral) before looking at products.
Ignoring fees and expenses	Significantly reduced overall returns, especially over long periods, making the annuity less effective than other investment options.	Create a spreadsheet to itemize and total all fees (management, surrender, rider, etc.) for each annuity and compare the net effect on your potential growth.
Not understanding surrender charges	Inability to access funds when needed without incurring substantial penalties, defeating the purpose of having a financial safety net.	Clearly note the length of the surrender period and the percentage charged for early withdrawal for each year of the surrender period.
Choosing the wrong annuity type	Mismatch between the product and your risk tolerance (e.g., high-risk variable annuity for someone seeking safety) or income needs.	Educate yourself on fixed, variable, and indexed annuities and select the type that best aligns with your risk profile and financial goals.
Overlooking the insurance company’s financial health	Risk of not receiving promised payments if the insurance company becomes insolvent, especially if you have a long-term payout.	Always check the financial strength ratings of the issuing insurance company from reputable agencies like A.M. Best, Moody’s, or S&P.
Misunderstanding income payout options	Receiving less guaranteed income than expected, or not having the flexibility needed for your retirement lifestyle.	Ask for specific illustrations of income payouts based on your investment amount, desired start date, and payout options (e.g., lifetime, joint and survivor).
Adding unnecessary riders	Increased costs and complexity without providing significant, essential benefits, reducing your net returns.	Only add riders that address a critical need that cannot be met otherwise, and carefully evaluate their cost versus their benefit.
Relying solely on salesperson advice	Potentially purchasing an annuity that benefits the salesperson more than you, due to commissions or sales incentives.	Seek advice from an independent, fee-only financial advisor who is a fiduciary and acts in your best interest.
Not reading the contract fine print	Being surprised by limitations, exclusions, or specific terms that affect your payouts, fees, or access to funds.	Take the time to thoroughly read and understand the annuity contract, or have an advisor review it with you.
Assuming annuities are for everyone	Investing in an annuity when other financial products might be more suitable, more liquid, or offer better returns for your specific situation.	Consider annuities as one tool among many for retirement planning and ensure they are the right fit after evaluating all other options.

Decision rules (how to compare annuities)

• If your primary goal is guaranteed lifetime income, then focus on annuities with strong income riders and compare the guaranteed withdrawal amounts.
• If you have a low risk tolerance, then prioritize fixed annuities over variable or indexed annuities.
• If you need access to your funds within the next 5-10 years, then an annuity with a long surrender period is likely not suitable.
• If you are seeking tax-deferred growth and plan to withdraw funds before age 59 ½, then be aware of potential IRS penalties on earnings, even within an annuity.
• If you want to protect your principal but also participate in market upside, then compare indexed annuities, paying close attention to caps, participation rates, and how gains are calculated.
• If the insurance company’s financial rating is below A- (or equivalent), then reconsider that annuity, as financial stability is critical for long-term promises.
• If the total annual fees (including rider costs) exceed 1.5% to 2% of the contract value, then scrutinize if the benefits justify the high cost, as this can significantly drag down returns.
• If you are comparing two annuities with similar features and costs, then consider the reputation and customer service of the issuing insurance company.
• If you are not comfortable with complex financial products, then stick to simpler fixed annuities or explore other retirement savings vehicles.
• If you want to leave a death benefit to heirs, then compare the guaranteed death benefit options and ensure they meet your legacy planning needs.
• If you are considering a variable annuity, then ensure you understand the underlying subaccount investment options and their associated risks and fees.
• If you can pay down high-interest debt with a guaranteed return higher than the annuity’s potential return, then prioritize debt repayment first.

FAQ

What is the difference between a fixed and a variable annuity?

A fixed annuity offers a guaranteed interest rate for a specified period, providing predictable growth. A variable annuity allows you to invest in subaccounts similar to mutual funds, with potential for higher returns but also the risk of loss.

Are annuities considered safe investments?

Annuities are generally considered safe, especially fixed annuities and those issued by financially strong insurance companies. However, variable annuities carry investment risk, and all annuities have surrender charges that can limit access to your money.

How do annuity fees affect my returns?

Annuity fees can significantly reduce your net returns. Common fees include mortality and expense charges, administrative fees, surrender charges for early withdrawal, and fees for optional riders.

Can I access my money from an annuity early?

You can typically access your money early, but you will likely incur surrender charges, which are a percentage of the withdrawn amount that decreases over time. There may also be IRS penalties if you withdraw earnings before age 59 ½.

What is a surrender charge?

A surrender charge is a penalty imposed by the insurance company if you withdraw money from your annuity before the end of a specified surrender period, which can last many years.

What is a guaranteed lifetime income rider?

This rider ensures you receive a guaranteed stream of income for your lifetime, regardless of how the underlying investments perform. It’s a popular feature for those seeking retirement income security.

How are annuities taxed?

Annuity earnings grow tax-deferred. You only pay ordinary income tax on the earnings when you withdraw them. Withdrawals made before age 59 ½ may also be subject to a 10% IRS penalty on the earnings portion.

Who should NOT buy an annuity?

Annuities may not be suitable for individuals who need liquidity, have high-interest debt to pay off, are very young and have a long time horizon for growth, or are uncomfortable with complex products and fees.

What is an indexed annuity?

An indexed annuity’s return is linked to a market index, like the S&P 500. It offers potential for growth based on the index’s performance but often includes caps or participation rates, and may have less downside risk than variable annuities.

What this page does NOT cover (and where to go next)

• Specific product recommendations and company reviews.
• Where to go next: Research independent financial advisory services.
• Detailed tax implications for every specific situation.
• Where to go next: Consult a tax professional or refer to IRS publications.
• Legal considerations and state-specific regulations.
• Where to go next: Consult an attorney specializing in financial planning or review state insurance department resources.
• Comparison with other retirement income strategies (e.g., pensions, Social Security, dividend stocks).
• Where to go next: Explore resources on comprehensive retirement planning.
• The mechanics of annuitization and payout phase calculations in extreme detail.
• Where to go next: Seek out specialized actuarial or financial planning resources.