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By Alex Diaz · How we calculate this
Put money into an annuity and a chunk of it is effectively locked up for years. Surrender charges typically start at 7% to 10% of a withdrawal in year one and step down roughly a point a year until they disappear, usually somewhere between year five and year ten depending on the contract.
These key factors affect annuity affordability
Annuity type drives the fee and risk structure
Fixed annuities work a lot like a CD sold by an insurance company: a guaranteed rate, fees usually under 1.5% a year, and no market risk. Variable annuities put the money into mutual-fund-style subaccounts and layer on a mortality and expense fee, often 1% to 1.5% by itself, on top of fund management fees and any optional riders, which together commonly push total annual costs to 2% or 3% or more. Indexed annuities sit in between: a return tied to a market index with a cap on the upside, in exchange for downside protection the other two types don't offer.
Surrender charges for early withdrawal
Need the money during years one through five or so and the surrender charge is steepest, often 7% to 10% of whatever you pull out beyond the penalty-free amount most contracts allow, typically 10% of the account value per year. That charge declines a point or two annually until it phases out entirely. The real cost of an annuity ends up highest for whoever needs liquidity sooner rather than later.
Payout structure options
A lifetime income payout keeps paying for as long as you live, even past the point where the account balance hits zero, but usually stops at death with nothing left for heirs. A period-certain payout guarantees payments for a set number of years and passes remaining value to a beneficiary if you die early, at the cost of a smaller check while you're alive.
Tax treatment
Growth inside an annuity compounds tax-deferred, which sounds like the same deal as a 401(k) or IRA, but withdrawal taxation isn't the same at all. Money taken out is taxed as ordinary income rather than the lower capital gains rate a brokerage account gets, and pulling money out before 59 1/2 can trigger a 10% early withdrawal penalty on top of that.
How to use your results
- Understand the surrender period and penalty schedule before committing your full amount, since early withdrawals can be costly for 5 to 10 years.
- Compare fixed, variable, and indexed annuity fee structures, since annual fees can vary by several percentage points.
- Consider your payout structure carefully, since lifetime versus period-certain payouts affect both your income and your heirs.
- Recheck how this purchase fits alongside your other retirement savings and existing debt, since it commits a large sum for years.
Ways to increase how much annuity you can afford
- Choose a fixed annuity over a variable or indexed product if your priority is predictable income with lower ongoing fees.
- Shop multiple insurers for the same annuity type, since payout rates and fees vary meaningfully between providers.
- Avoid unnecessary riders like income guarantees or death benefits you don't need, since each one adds to the annual fee.
- Consult a fee-only financial advisor before committing, since annuities are commissioned products and advice can vary in objectivity.
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