How you buy an annuity depends on what type you want and whether you're using retirement savings or new money
You buy an annuity by contacting an insurance company, a financial advisor, or a bank that sells them, then completing an process and funding the contract. The process itself takes a few days to a few weeks. The harder part is deciding which type makes sense for your situation — whether you want when ready income, growth with tax deferral, a may provide return, or some mix — and understanding how the purchase affects your taxes and retirement plan.
If you're using money from a retirement account like an IRA or 401(k), the rules are stricter and the tax timing matters. If you're using after-tax savings, you have more flexibility but will owe taxes on the gains when you withdraw them. Either way, you should know the surrender charges, the fees, and what happens to your money if you need it back.
Key Takeaways
- You can buy an annuity directly from an insurance company, through a financial advisor, or via a bank, and the process process typically takes one to three weeks.
- Annuities bought with retirement account money are subject to required minimum distribution rules and early withdrawal penalties if you access the money before age 59½.
- Surrender charges — penalties for withdrawing more than a small amount in the first five to ten years — are common and can be steep, so understand them before you commit.
- The tax treatment differs sharply: gains in a deferred annuity are taxed as ordinary income when withdrawn, while when ready annuities spread the tax over the life of the payout.
- You should compare the insurance company's financial rating, the fees charged, and the payout terms across at least two or three providers before deciding.
Where to buy an annuity and what to expect from each source
You have three main channels: directly from an insurance company, through a financial advisor or broker, or through a bank. Each has trade-offs.
Direct from an insurance company: You contact the insurer — Fidelity, Vanguard, Schwab, Equitable, Principal, and Allianz are large players — and they walk you through the process online or by phone. You control the terms and see exactly what you're paying. The downside is that you do all the research yourself and have no advisor to explain the contract language or help you think through whether an annuity fits your plan.
Through a financial advisor or broker: An advisor can compare products across multiple insurers and help you understand the trade-offs. They are paid either by commission (built into the annuity price) or by a flat fee you pay directly. Commission-based advisors have an incentive to sell you a higher-commission product, so ask upfront how they are paid. The process still goes to the insurance company, but the advisor handles the paperwork and coordinates funding.
Through a bank: Some banks sell annuities as part of their wealth management services. The process is similar to working with an advisor, but the bank may have relationships with only a few insurers, limiting your options.
Whichever route you choose, the insurance company will ask for personal information (age, health, income), details about the money you're using to fund it, and your beneficiary. If you're using retirement account money, they'll need to know the account type and whether you're rolling over or transferring funds. The underwriting usually takes one to three weeks.
Funding an annuity with retirement account money versus after-tax savings
The source of your money changes the rules and the tax outcome.
Retirement account money (IRA, 401(k), 403(b)): You can roll over or transfer funds directly to an annuity contract. The money stays tax-deferred until you withdraw it. However, if you buy the annuity before age 59½, you may face a 10% early withdrawal penalty on any withdrawals beyond the annuity's scheduled payments — the IRS calls this the "substantially equal periodic payment" exception, and it applies to annuities, but only if the payments are truly periodic and you stick to them. If you're still working and the money is in your current employer's 401(k), you may not be able to roll it to an annuity without leaving the job first. Check with your plan administrator. Once you turn 73 (as of 2023), you must take required minimum distributions from the annuity, which affects how much income you receive and when.
After-tax savings: You can fund an annuity with money from a taxable brokerage account, a savings account, or a certificate of deposit. The money you put in (your "cost basis") is not taxed again when you withdraw it. But the gains — the interest, dividends, or appreciation that happened before you bought the annuity — are taxed as ordinary income when you receive them. If you're buying an when ready annuity (one that starts paying you right away), part of each payment is a return of your basis (tax-free) and part is gain (taxable). The insurance company will tell you the "exclusion ratio," which tells you what percentage of each payment is tax-free. With a deferred annuity, you pay tax on all gains when you withdraw.
Understanding surrender charges and early withdrawal penalties
Most annuities, especially deferred ones, come with a surrender charge — a penalty if you withdraw more than a small amount (usually 10% per year) during the first five to ten years. The charge typically starts high (5% to 10% of the withdrawal) and declines each year. If you surrender the contract entirely, you pay the full charge on the amount you withdraw.
This is different from the 10% early withdrawal penalty on retirement accounts. If you buy an annuity with IRA money and then withdraw from it before 59½, you may owe both the surrender charge (to the insurance company) and the early withdrawal penalty (to the IRS), plus income tax on the gains. Some annuities waive the surrender charge if you become disabled or need long-term care, or if you die — read the contract to see what's covered.
Before you buy, ask the insurance company for the surrender schedule in writing. If you think you might need the money within five years, a deferred annuity is probably not the right choice. An when ready annuity has no surrender charge because you're already receiving the payout.
How taxes work when you receive annuity payments
The tax treatment depends on the type of annuity and the source of the money.
when ready annuity with after-tax money: Each payment includes a return of your basis (tax-free) and a portion of gain (taxable). The insurance company calculates the exclusion ratio based on your age, the payout period, and the total you paid in. For example, if you paid $100,000 for an when ready annuity and the insurer expects to pay you $200,000 over your lifetime, your basis is 50% of each payment, so half of each check is tax-free and half is taxable. You report the taxable portion on your tax return each year.
Deferred annuity with after-tax money: While the money grows inside the annuity, you owe no tax. When you withdraw, you pay tax on all gains first (last-in-first-out), then you recover your basis tax-free. If you withdraw $50,000 and the annuity has $30,000 in gains, you owe tax on the $30,000 and get the remaining $20,000 tax-free.
Any annuity with retirement account money: All withdrawals are taxed as ordinary income, because the entire account is pre-tax. There is no exclusion ratio or basis recovery — the IRS treats it all as deferred income.
Comparing annuity providers and contract terms
Not all annuities are the same, and the insurer's financial strength matters because they're the one promising to pay you for decades. Before you commit, gather quotes from at least two or three companies.
Compare these specifics: the may provide payout rate (for when ready annuities), the fees and expense ratios (for variable annuities), the surrender schedule, any riders or add-ons (like a death benefit or long-term care rider), and the insurer's financial rating from A.M. Best or Moody's. A lower payout rate from a weaker insurer is not a bargain. Check the National Association for Insurance Commissioners (NAIC) database if you want to see complaints filed against a company.
Ask whether the contract allows you to change your mind within a certain period (usually 10 to 30 days) without penalty — this is called a "free look" period. Use it. Read the contract summary and the detailed prospectus before you fund the annuity. If something is unclear, ask the company or your advisor to explain it in writing.
Tax timing and coordination with your overall retirement plan
Buying an annuity can affect your tax bracket, your Medicare premiums, and your required minimum distributions, so it's worth thinking through the timing.
If you're in a low-income year (say, you retired early or took a sabbatical), funding an annuity with a large lump sum might push you into a higher tax bracket. Spreading the purchase over two or three years can smooth your income. If you're over 73 and subject to required minimum distributions, buying an annuity with IRA money can reduce the amount you must withdraw each year, because the annuity itself counts toward the RMD — but only if it's set up correctly, so work with a tax advisor or the plan administrator.
If you're on Medicare, a large withdrawal to fund an annuity could increase your income-related premiums for the next two years (because Medicare looks back at your tax return from two years prior). Again, timing the purchase across two tax years might help.
What happens if you need to access your money early
Life changes. If you buy an annuity and then face a financial emergency, your options are limited and expensive.
With a deferred annuity, you can withdraw up to 10% of the value per year (in most contracts) without a surrender charge. Anything beyond that triggers the surrender charge. If you withdraw from a retirement account annuity before 59½, you also owe the 10% early withdrawal penalty on the taxable portion. With an when ready annuity, you cannot access a lump sum — you receive only the scheduled payments.
Some annuities offer a "liquidity rider" or "withdrawal benefit" that lets you access more money penalty-free, but this costs extra and reduces your payout. If you think you might need flexibility, ask about this option before you buy. Otherwise, only fund an annuity with money you're confident you won't need for at least five to ten years.
Frequently Asked Questions
Can I buy an annuity inside a 401(k) or IRA?
Yes. Many 401(k) plans and IRAs allow you to purchase an annuity with the account balance. With a 401(k), you may need to leave the job first or have the plan administrator approve it. With an IRA, you can buy directly. The annuity remains inside the account, so the money stays tax-deferred until you withdraw it.
What's the difference between buying an annuity and just leaving money in a savings account?
An annuity guarantees you a specific income for life (or a set period), whereas a savings account gives you interest that may be low and can change. An annuity locks in your rate and protects you from outliving your money, but you lose access to the principal. A savings account is liquid but offers no longevity protection.
Do I need a financial advisor to buy an annuity?
No, but it helps. An advisor can explain the contract, compare products, and help you decide if an annuity fits your plan. If you're comfortable reading the prospectus and making the decision alone, you can buy directly from an insurer. Either way, take time to understand what you're buying before you commit.
Can I change my mind after I buy an annuity?
Most annuities include a "free look" period of 10 to 30 days during which you can cancel and get your money back with no penalty. After that, you're locked in. If you want to exit early, you'll owe the surrender charge. Check your contract for the free look terms.
What happens to my annuity if the insurance company fails?
Each state has a guaranty fund that protects annuity holders if an insurer becomes insolvent. Coverage limits vary by state but typically range from $100,000 to $500,000 per person per insurer. This is why checking the insurer's financial rating before you buy is important — it reduces the risk of needing that protection.