An annuity is not universally good or bad — it depends on your age, how much you have saved, what you need the money for, and what fees you'll pay

An annuity converts a lump sum of money into a stream of payments over time, usually for the rest of your life. That structure solves a real problem: the risk that you'll live longer than your savings last. But annuities come with costs — insurance company fees, surrender charges if you need your money back early, and often lower returns than you could get elsewhere. Whether one makes sense for you depends on whether the longevity protection is worth what you're giving up.

The decision also depends on what you already have. If you have a pension and Social Security, you may not need an annuity at all. If you have almost nothing saved and are approaching retirement, an annuity might be the only way to may provide income. If you're in your 40s with decades to go, you probably have better options.

Key Takeaways

  • An annuity protects you against outliving your money, but that protection costs money in fees and lower returns.
  • If you already receive a pension and Social Security, you may already have enough may provide income and should think carefully before buying an annuity.
  • Annuities make more sense the older you are and the less time you have to recover from market losses.
  • Variable annuities and indexed annuities carry higher fees and complexity than when ready annuities, and the extra cost often outweighs the benefit.
  • Before buying any annuity, compare the monthly payment amount to what you could get from a different insurance company — prices vary widely for the same person.

When an annuity actually solves a problem you have

An annuity works best when you have a specific gap in your retirement income. Suppose you're 70, you have $300,000 in savings, and you receive $2,000 a month from Social Security. You need $4,000 a month to live on. An when ready annuity could turn that $300,000 into roughly $1,500 to $2,000 a month for life, closing the gap. You've traded a lump sum for may provide income you cannot outlive.

This is most useful if you have no pension, your Social Security is modest, and you're worried about living into your 90s or beyond. The older you are when you buy, the higher the monthly payment, because the insurance company expects to pay you for fewer years. A 75-year-old gets more per month than a 65-year-old from the same $300,000.

An annuity also makes sense if you're the type of person who will spend down savings too quickly or make poor investment decisions under stress. If you know you'll panic-sell stocks in a market downturn, locking in a fixed payment removes that temptation.

When you probably should not buy an annuity

If you have a pension from an employer, you already have may provide lifetime income. Adding an annuity on top means you're paying twice for the same protection. The same logic applies if your Social Security is substantial — say, $3,000 or more per month — and covers most of your expenses.

If you're younger than 60 and still working or have decades until retirement, an annuity locks up money you might need for emergencies, home repairs, or health costs. Annuities typically charge steep penalties — sometimes 7 to 10 percent — if you withdraw money in the first five to ten years. A market downturn at age 45 is something you can recover from over time; locking in a fixed payment at 45 means you miss out on any recovery.

If you have less than $100,000 to invest, the fees often eat up so much of the return that you're better off with a straightforward savings account or a low-cost investment fund. Annuity fees are usually quoted as a percentage of your balance each year, and on a small balance, that percentage adds up to very little money in your pocket.

How fees and complexity reduce what you actually receive

An when ready annuity is straightforward: you pay a lump sum, the insurance company pays you a fixed amount each month for life. There are no ongoing fees beyond what's already baked into the monthly payment. A 70-year-old might get $500 per month for every $100,000 invested, depending on interest rates and the insurance company.

A variable annuity or indexed annuity is more complicated. You pay a lump sum, but the monthly payment depends on how well the underlying investments perform. The insurance company charges you an annual fee — often 1 to 3 percent of your balance — plus fees for the investments themselves. These products promise upside if markets do well, but you're paying for that possibility whether or not it happens. In most cases, the fees are so high that you would have done better buying an when ready annuity or investing on your own.

A deferred annuity lets you invest money now and delay taking payments until later — say, at age 80. This can make sense if you want to lock in a payment rate while you're younger, but again, the fees are substantial, and you're betting that you'll live long enough for the strategy to pay off.

What to compare before you buy

If you decide an when ready annuity makes sense, the monthly payment you receive varies significantly by insurance company. A $300,000 investment might get you $1,600 a month from one company and $1,750 from another — that's $1,800 a year in difference, or $36,000 over 20 years. Always get quotes from at least three companies before deciding.

Ask whether the payment is fixed for life or whether it adjusts for inflation. A fixed payment of $1,500 a month sounds good until inflation erodes its value over 20 years. Some annuities offer a cost-of-living adjustment, usually 2 or 3 percent per year, but that adjustment reduces your starting payment. The trade-off is real: you start with less, but your payment grows over time.

Also ask what happens to your money if you die soon after buying. Some annuities pay nothing to your heirs if you die at 71 after buying at 70. Others offer a "period certain" option — if you die within, say, 10 years, your heirs receive the remaining payments. That option costs you money in the form of a lower monthly payment, but it may matter to you.

The role of your overall financial picture

An annuity should not be your only retirement strategy. It should fill a specific gap. If you have $500,000 in savings, a pension of $2,000 a month, and Social Security of $2,500 a month, you may not need an annuity at all. You already have $4,500 in may provide income, and you have a large cushion for unexpected costs.

If you have $200,000 in savings, no pension, and Social Security of $1,500 a month, an annuity might make sense for part of that $200,000 — perhaps $100,000 — to create an additional $800 to $1,000 a month. You'd keep the rest in accessible savings or investments for flexibility.

Work backward from your expenses. Write down what you need each month. Subtract what you already receive from Social Security and any pension. The gap is what an annuity could fill. Then decide whether paying for that may provide is worth the cost and the loss of flexibility.

Common mistakes people make when considering annuities

One mistake is buying an annuity because a salesperson says it's a good investment. Annuities are not investments in the traditional sense — they're insurance products. A salesperson who earns a commission on the sale has a financial incentive to sell you one, regardless of whether it's right for you. Always get independent information before deciding.

Another mistake is buying a variable or indexed annuity when an when ready annuity would do the job. The extra complexity and fees rarely pay off. If you want growth potential, invest in a diversified fund. If you want may provide income, buy an when ready annuity. Mixing the two in one product usually gives you the worst of both.

A third mistake is buying too much annuity too early. If you're 55 and buy an annuity, you're locking in a payment rate that may not be favorable. Interest rates change, and you might get a better rate at 65 or 70. Unless you have a specific reason to buy now, waiting often makes sense.

Frequently Asked Questions

Can I get my money back if I change my mind after buying an annuity?

Most annuities have a surrender period of five to ten years. If you withdraw money during that time, you pay a penalty — often 7 to 10 percent of the amount withdrawn. After the surrender period ends, you can usually withdraw without penalty, but you lose the may provide income stream. Read the contract carefully before buying.

What if I die shortly after buying an annuity?

With a basic when ready annuity, the insurance company keeps any remaining balance. If that concerns you, you can add a "period certain" rider — for example, guaranteeing payments for at least 10 years. If you die within that period, your heirs receive the remaining payments. This option reduces your monthly payment but protects your heirs.

Is an annuity better than keeping money in the bank?

An annuity typically pays more per month than you'd earn in interest from a savings account, because the insurance company invests your money and takes a cut. But you lose access to the money. If you need flexibility and don't mind a lower return, a savings account is simpler. If you want may provide income and won't need the lump sum, an annuity may pay more over time.

Should I buy an annuity with my 401(k) or IRA?

You can use retirement account money to buy an annuity, and it may make sense if you want to lock in income for part of your retirement savings. However, you'll still owe taxes on the withdrawals, and you lose the flexibility of the retirement account. Consult a tax professional before moving retirement money into an annuity.

How do I know if an annuity salesperson is trustworthy?

Ask whether they are a fiduciary — meaning they are legally required to act in your best interest, not theirs. Ask how they are compensated; if they earn a commission on the sale, they have an incentive to sell you something. Get quotes from multiple companies and compare them yourself rather than relying on one salesperson's recommendation.