The basic path to buying an annuity

You buy an annuity by working with an insurance company or a financial professional who sells them — typically an insurance agent, broker, or financial advisor. You choose the type of annuity (when ready, deferred, fixed, variable), decide how much to invest, and sign a contract. The insurance company then holds your money and pays you according to the schedule you chose. The whole process usually takes two to four weeks from contract to first payment.

Most people buy annuities in one of three ways: directly from an insurance company's website or phone line, through a financial advisor or broker who represents multiple companies, or as part of a retirement plan rollover. Each route has different costs and different people involved in the decision.

Key Takeaways

  • You can buy directly from an insurance company, through a broker who compares multiple companies, or as part of a rollover from a 401(k) or IRA.
  • Commissions (typically 3 to 10 percent of your investment) are built into the price you pay, whether you see them listed or not.
  • You will need to decide between when ready annuities (payments start within a year) and deferred annuities (payments start later), and between fixed rates and variable returns tied to investments.
  • Annuities have surrender charges if you withdraw money early, usually lasting 5 to 10 years, so only invest money you do not plan to touch.
  • A financial advisor or tax professional can help you decide whether an annuity fits your retirement plan and whether a rollover makes sense for your situation.

Buying directly from an insurance company

You can contact an insurance company directly — Fidelity, Vanguard, Schwab, Equitable, Principal, and Nationwide all sell annuities online or by phone. You will answer questions about your age, how much you want to invest, when you want payments to start, and how long you want them to last (your lifetime, a set number of years, or until a surviving spouse dies). The company will quote you a monthly or annual payment amount based on current interest rates and your life expectancy.

The advantage of buying direct is that you see fewer middlemen. The disadvantage is that you are comparing one company's products at a time, and you cannot easily shop across multiple insurers in one conversation. You also need to understand the contract terms yourself — there is no advisor to explain what a "7-year surrender period" means or whether a variable annuity's fees are reasonable for your situation.

Working with a broker or financial advisor

A broker or advisor can show you annuities from multiple insurance companies and help you compare rates, fees, and contract terms. They earn a commission — typically 3 to 10 percent of the amount you invest — paid by the insurance company, not by you separately. That commission is built into the price you receive, so you will not see a separate bill for it.

The advantage is that you get a second opinion and can compare options. The disadvantage is that the advisor's incentive is to close the sale, not necessarily to steer you toward the cheapest option or to talk you out of buying if an annuity does not fit your plan. Ask the advisor upfront what their commission is and whether they are required to recommend the lowest-cost option or straightforward a "suitable" one. This matters because suitability is a lower standard than best-interest information.

Rolling over a 401(k) or IRA into an annuity

If you have a 401(k) from a former employer or an existing IRA, you can roll that money into an annuity without paying income tax on it at the time of the transfer. This is called a direct rollover if the money moves straight from the old account to the annuity, or an indirect rollover if you receive a check and deposit it yourself within 60 days.

A direct rollover is simpler and safer — there is no risk of missing the 60-day important date or accidentally triggering a tax bill. To do a direct rollover, contact your old plan administrator (or the IRA custodian) and ask them to send the funds directly to the insurance company in the name of your IRA or the annuity contract. The insurance company can provide the wire instructions.

Rolling over into an annuity makes sense if you want to convert a lump sum into may provide lifetime income, or if you are past age 73 and want to satisfy your required minimum distribution (RMD) using an annuity instead of taking cash. It does not make sense if you need access to the money soon, because annuities charge surrender fees for early withdrawal.

Understanding costs and surrender charges

Annuities have several layers of cost. The commission (3 to 10 percent) is paid to the agent or broker and is built into the price. If you buy a variable annuity, there are annual management fees (often 0.5 to 2 percent per year) charged by the investment managers. There may also be rider fees if you add options like a death benefit or a may provide income floor.

Most annuities also have a surrender period — typically 5 to 10 years — during which you cannot withdraw more than a small amount (often 10 percent per year) without paying a penalty. The penalty usually starts at 7 to 10 percent of the withdrawal and declines each year. This is not a tax; it is a contract penalty charged by the insurance company. If you withdraw during the surrender period, you owe both the penalty and income tax on any gains.

Before you buy, ask the insurance company or broker for a fact sheet or prospectus that lists all fees and the surrender schedule. Compare the total cost across companies, not just the payment amount, because a slightly lower payment from a company with lower fees may be a better deal over time.

What happens after you sign the contract

Once you sign, the insurance company will send you a copy of the contract and a disclosure document. You typically have a 10 to 30-day free-look period (the length varies by state) during which you can cancel and get your money back with no penalty. Use this time to review the contract carefully or have a tax professional or advisor review it for you.

After the free-look period ends, you are locked in. If you bought an when ready annuity, payments usually start within 30 to 60 days. If you bought a deferred annuity, your money grows (either at a fixed rate or in investment accounts you choose) until you decide to start taking payments, which can be years later.

The insurance company will send you a 1099-R form each year showing how much you received and how much is taxable. The tax treatment depends on whether the annuity is in a retirement account (like an IRA) or outside one, and whether you bought it with pre-tax or after-tax dollars. A tax professional can help you understand your tax bill each year.

When to talk to a professional before buying

An annuity is a long-term commitment with real penalties for changing your mind, so it makes sense to get a second opinion before you sign. A fee-only financial advisor (one who charges you directly rather than earning commissions) can review your retirement plan and tell you whether an annuity fits, what type makes sense, and how much to invest. A tax professional can model how the annuity will affect your taxes in retirement and whether a rollover makes sense for your situation.

You should also talk to a professional if you are considering a variable annuity with complex riders, if you are over 75 and considering an when ready annuity, or if you are thinking about investing more than 25 to 30 percent of your retirement savings in annuities. These situations have trade-offs that deserve a careful look.

Frequently Asked Questions

Can I buy an annuity inside a retirement account like an IRA?

Yes. You can buy an annuity inside an IRA, a 401(k), or a similar plan. The advantage is that the money grows tax-deferred. The disadvantage is that you still cannot withdraw without penalty until age 59½ (with some exceptions), so you are adding the annuity's surrender charges on top of the IRA's early-withdrawal rules.

What if I change my mind after I buy?

You have a free-look period (10 to 30 days, depending on your state) to cancel and get your full investment back. After that, you can withdraw money but will owe a surrender charge, which typically ranges from 7 to 10 percent in year one and declines each year. You will also owe income tax on any gains.

Do I need a financial advisor to buy an annuity?

No, but it is worth considering one. An advisor can compare options across multiple companies, explain the contract terms, and help you decide whether an annuity fits your overall plan. If you buy direct from an insurance company, you are making that decision alone.

What is the difference between buying an when ready annuity and a deferred annuity?

An when ready annuity starts paying you within a year of purchase, usually within 30 to 60 days. A deferred annuity lets your money grow for years before you start taking payments. when ready annuities lock in today's interest rates right away; deferred annuities let you wait for rates to rise, but you take the risk that rates could fall instead.

Can I buy an annuity with money from a Roth IRA?

Yes, but the tax treatment is different. Money in a Roth grows tax-free, so if you buy an annuity inside a Roth, the payments are tax-free too (as long as you follow Roth withdrawal rules). You still cannot access the money penalty-free before age 59½, so you are combining the annuity's surrender charges with the Roth's early-withdrawal restrictions.