When an annuity is not right for you

We sell annuities. So it may seem odd that one of the first articles on our site is about when you should not buy one.

Here is the reason. An annuity is a long-term contract. Once you sign, getting out early can cost real money. The best time to find out an annuity is wrong for you is before you sign, not after. If you are asking “is an annuity a good idea at 60?” the honest answer is: it depends on the rest of your picture. This article walks through the situations where the answer is usually no.

First, what an annuity is

An annuity is a contract with an insurance company. You pay the insurer money, either in one lump sum or over time. In return, the insurer promises something back later: interest credited to your contract, a stream of income, or both.

Washington’s insurance regulator describes it the same way: a contract with an insurer that can provide steady income and lets earnings grow tax-deferred until you take money out. Tax-deferred means you do not pay income tax on the growth each year. You pay it later, when you withdraw. Withdrawals of earnings are normally taxed as ordinary income.

An annuity is not an investment in the stock market, and it is not a bank account. It is an insurance contract. Its promises are only as strong as the insurance company behind them.

That trade is the heart of it. You give up some access and flexibility. In exchange, you get promises in writing. Whether that trade is worth it depends on you.

You may need the money in the next several years

This is a common reason an annuity is wrong.

Most deferred annuities have a surrender charge. That is a fee the insurer keeps if you cancel the contract or take out more than the contract allows during the early years. The period when the fee applies is called the surrender period.

Washington’s regulator says these charges are usually 5% to 10% of the amount you take out. It also says insurers can charge them for an average of about seven years. The charge is usually highest in the first year and shrinks over time. Your contract will list the exact schedule.

On top of that, if you take money out before age 59½, the IRS may add a 10% additional tax on the taxable part. IRS Publication 575 covers this rule and its exceptions.

So ask yourself plainly. Could you need this money for a roof, a car, a medical bill, or to help a family member before the surrender period ends? If the answer is “maybe,” keep that money somewhere you can reach without a penalty.

You do not have an emergency fund yet

An annuity should not be the place your emergency money lives. If you do not have several months of expenses set aside somewhere easy to reach, build that first.

This matters because life rarely waits for a surrender schedule. Putting too much into an annuity raises the chance you will need to withdraw early and pay surrender charges.

You are paying off high-interest debt

If you carry credit card balances or other high-interest debt, paying that down is often a better use of the money. The interest you avoid is certain. Talk this through with a tax professional or a fee-only planner if you are unsure. We can walk through the tradeoffs, but we will tell you if paying off debt comes first.

You already have the income you need

Some people have a pension, Social Security, and other income that already covers their monthly budget with room to spare. For them, an income annuity may add little. It can also lock up money they might rather leave flexible or pass on.

A simple test: add up your guaranteed monthly income and compare it with your monthly spending. If the gap is zero or close to it, the case for an annuity is weaker. Our retirement income gap estimator on the retirement income page helps you do that math.

You want market-level growth

A fixed annuity credits interest at a rate the insurer sets. A fixed indexed annuity credits interest based partly on a market index, but with limits such as caps and participation rates. Neither is designed to match the full gains of the stock market.

If your goal is to capture as much market growth as you can, an annuity is the wrong tool. That is not a flaw. It is the tradeoff for having limits on the downside. We explain those limits in caps, participation rates and surrender charges, explained.

You are being asked to replace an annuity you bought recently

Sometimes an agent suggests cashing out an annuity you already own to buy a new one. This is called a replacement. It can make sense in some cases. It can also restart a surrender period and cost you money.

Washington’s regulator lists a few warning signs. Pressure to buy the same day is one. A suggestion to replace an annuity you bought recently is another. So is a “free” seminar that leads to a private sales appointment. An agent who recommends a replacement should be able to explain, in writing, what you give up and what you gain.

You do not understand the contract yet

If you cannot explain in your own words how your annuity credits interest, what the surrender charges are, and how you get money out, you are not ready to sign. That is not a judgment. These contracts are complicated.

The NAIC (National Association of Insurance Commissioners, the group of state insurance regulators) publishes a Buyer’s Guide for Deferred Annuities. It is free. Read it, or ask us to walk through it with you.

You feel rushed

A good decision about a long-term contract can wait a week. If anyone tells you a rate or feature will vanish unless you sign today, slow down.

Ask about the free look period. That is a short window after the contract arrives when you can return it for a refund. Washington’s consumer guidance, for example, describes a 10-day window. The length varies by state and situation, so check your contract.

When an annuity may fit

To be fair, here is the other side. An annuity may be worth a look when:

• You have money you are confident you will not need during the surrender period.
• You already have an emergency fund.
• You want part of your retirement income to be predictable.
• You understand and accept the limits on growth and access.

Even then, it is usually one piece of a plan, not the whole plan.

What we do before any recommendation

We start with a written fact-find. We look at your income, your spending, your timeline, and the money you need to keep reachable. Then we show you options side by side, including the option of doing nothing. You decide on your own time. If an annuity is not right for you, we will tell you. You can read more on how we work.

For tax questions, including how withdrawals would be taxed in your situation, talk with a tax professional. We do not give tax advice.