Few financial products spark as much debate as annuities. They promise something almost irresistible: guaranteed income for life. And that promise is why they’re sold so aggressively. In 2024 alone, annuity sales in the United States topped $400 billion, a record-setting year driven largely by fixed and fixed indexed products.
But here’s what often gets lost in the sales pitch: an annuity’s guarantee comes with significant tradeoffs, and the person recommending one to you may be earning a substantial commission for doing so. That doesn’t automatically make the recommendation wrong, but it does mean you should understand the full picture before signing a contract that could lock up your money for a decade or more.
A Quick Look at Annuity Types
“Annuity” isn’t a single product. It’s a broad category that includes several very different contracts. The pros and cons vary depending on the type, so it’s worth understanding the basics.
Fixed annuities pay a guaranteed interest rate for a set period, similar to a certificate of deposit. They’re straightforward, low-risk, and relatively low-cost.
Fixed indexed annuities tie your interest to the performance of a market index like the S&P 500. You won’t lose principal in a down market, but caps, participation rates, and spreads limit how much of the upside you actually capture. These are among the most commonly sold, and most commonly misunderstood, annuity products.
Variable annuities let you invest in subaccounts that function like mutual funds. They offer more growth potential but carry investment risk, and their fee structures can be the most expensive of any annuity type.
Income annuities (immediate or deferred) convert a lump sum into a stream of guaranteed payments, either right away or starting at a future date. They’re the simplest version of the “guaranteed income for life” promise.
Each type has a different risk profile, fee structure, and best-case use. One of the most common problems we see is people being sold the wrong type of annuity for their situation, or being sold an annuity when they didn’t need one at all.
What Annuities Do Well
Annuities can offer meaningful benefits in the right situations, and it’s worth understanding where they may fit.
Guaranteed Lifetime Income
This is the core value proposition, and it’s real. No other retail financial product can contractually guarantee that you’ll receive income for the rest of your life, regardless of market conditions or how long you live. For someone genuinely concerned about outliving their savings, and who has already built a solid financial foundation, that guarantee can fill an important gap.
The key phrase there is “who has already built a solid financial foundation.” An annuity should be a complement to a well-designed plan, not a substitute for one.
Tax-Deferred Growth
Money inside an annuity grows tax-deferred, similar to a traditional IRA or 401(k). For someone who has already maxed out their other tax-advantaged accounts, this can be a secondary benefit worth considering.
Downside Protection
Fixed and fixed indexed annuities protect your principal from market declines. For very conservative investors who would otherwise keep large sums in cash or low-yielding savings accounts, that protection, paired with modestly higher returns, may be appropriate.
Behavioral Guardrails
For some people, the structure of an annuity removes the temptation to make emotional decisions when markets decline. That behavioral benefit has real value, even if it doesn’t show up on a spreadsheet.
Where Annuities Fall Short, And Where They're Oversold
It’s also important to understand where annuities can fall short and where they may be oversold.
The Commission Problem
Let’s address the elephant in the room. Many annuities, particularly fixed indexed and variable annuities, pay the selling advisor a commission, and it can be a large one. Commissions on fixed indexed annuities commonly range from 5% to 8% of the total premium. On a $300,000 annuity, that’s $15,000 to $24,000 paid to the advisor, funded by the insurance company.
That commission isn’t deducted from your account directly, but it’s not free money either. The insurer recoups that cost through surrender charges, caps, spreads, and other product design features that limit your returns and flexibility over time. In other words, you pay for it. Just not in ways that are always obvious.
We aren’t saying every commission-based annuity recommendation is bad. But when someone stands to earn a sizable commission for selling a product, it’s reasonable to ask how that compensation may be influencing that recommendation.
As a fee-only fiduciary firm, our advice isn’t driven by product commissions. When we evaluate an annuity for a client, the only question we’re asking is whether it genuinely serves their financial plan.
Fees That Add Up Quietly
Variable annuities are the most expensive, often layering mortality and expense charges (commonly around 1.25%), administrative fees, underlying fund expense ratios, and optional rider costs. Total annual fees can exceed 3% per year. Over a 20-year period, that fee drag can consume a meaningful portion of your returns.
Fixed indexed annuities may appear to have fewer explicit fees, but the cost is embedded in the product’s design. Caps limit how much you earn in strong market years. Participation rates give you only a percentage of the index’s return. Spreads subtract from your gains before interest is credited. The insurance company isn’t offering downside protection for free. These features are how they pay for it and fund the commissions.
The total cost of an annuity isn’t always easy to calculate, and that’s part of the problem. If you can’t clearly articulate what you’re paying, it’s worth asking why.
Your Money Is Locked Up
Most deferred annuities impose a surrender period, typically six to ten years, during which withdrawals beyond a small annual allowance trigger a penalty. A common surrender schedule starts at 7% in the first year and declines by roughly one percentage point annually until it reaches zero.
On top of that, the IRS may impose its own 10% early withdrawal penalty if you’re under age 59½.
Life doesn’t always follow a plan. Medical expenses, family needs, career changes, or new opportunities can arise at any time. Having a significant portion of your savings locked inside a product with limited access, and steep penalties for early withdrawal, is a risk.
Unfavorable Tax Treatment on the Back End
Tax-deferred growth sounds appealing on the front end, but when you withdraw money from an annuity, the gains are taxed as ordinary income, not at the lower long-term capital gains rate that applies to most investment accounts. For someone in a higher tax bracket, this difference can be substantial.
Annuities also do not receive a step-up in cost basis at death. If you leave annuity assets to your heirs, they may face a larger tax bill than they would on inherited stocks, mutual funds, or ETFs. For clients focused on legacy planning, this is an important consideration.
It’s also worth noting that if an annuity includes an income rider, the death benefit paid to heirs is typically based on the actual account value, not the higher income benefit base. The income benefit base may “grow” at an attractive rate on paper, but that figure exists only for calculating guaranteed withdrawals during the owner’s lifetime. At death, the roll-up value generally goes away, and beneficiaries receive the lesser account value. This distinction surprises many families and is one more reason to understand exactly what you own.
Complexity That Favors the Seller
Annuity contracts can run dozens of pages. Caps, participation rates, roll-up rates, benefit bases, crediting methods, rider fees. The terminology alone can be overwhelming. And in our experience, when a financial product is this complex, the complexity tends to benefit the company selling it more than the person buying it.
We’ve sat down with clients who remember the annuity sounding like a good idea when it was sold to them but can no longer recall why they bought it or how the moving parts actually work. When a product is that hard to understand after the fact, it’s worth asking whether it was the right fit in the first place.
The Opportunity Cost Is Real
Every dollar committed to an annuity is a dollar that isn’t invested in a diversified portfolio. Over long time horizons, a well-constructed mix of stocks and bonds has historically offered stronger growth potential than most annuity products, even accounting for market downturns along the way.
When we run financial planning scenarios for our clients, we’re testing thousands of possible outcomes over decades. In many cases, a thoughtfully managed investment portfolio, paired with smart tax planning and a disciplined withdrawal strategy, can provide a strong long-term outcome without the tradeoffs that come with an annuity.
That doesn’t mean annuities never win the math. But it does mean the burden of proof should be on the annuity to justify its place in the plan, not the other way around.
When Might an Annuity Make Sense?
Here are situations where an annuity can genuinely add value:
- You need an income floor and have the resources to fund one. If your essential expenses exceed what Social Security and any pension income cover, and you have sufficient other assets to maintain liquidity and growth, annuity income can provide peace of mind.
- Longevity is a real concern. If you have a family history of living into your 90s and are worried about portfolio sustainability over a 30+ year retirement, guaranteed lifetime income can be a reasonable hedge.
- You’ve exhausted other tax-advantaged options. If you’ve maxed out your 401(k), IRA, and HSA and are looking for additional tax-deferred growth, an annuity is one of the few remaining vehicles.
- A simple, low-cost fixed annuity fits your risk profile. For very conservative investors who would otherwise sit in cash, a fixed annuity offering a guaranteed rate may be a reasonable alternative, as long as the surrender period aligns with your time horizon.
The common thread in each of these scenarios is that the annuity is solving a specific, well-defined problem within a broader plan. If you’re considering an annuity, it’s worth making sure you can clearly articulate what role it plays and what alternatives you’ve weighed.
Our Perspective
We believe in building retirement income plans that are transparent, flexible, and grounded in evidence. That usually means a diversified investment portfolio managed with tax efficiency in mind, a clear withdrawal strategy, and a plan that adapts as your life changes.
Annuities can sometimes complement that approach. But in our experience, they work best when they’re used selectively, for a clear purpose, and only after other options have been carefully considered.
If you own an annuity and aren’t sure whether it’s still serving you well, or if someone has recommended one and you’d like a second opinion, we’re happy to take a look. We’ll give you a candid assessment with your best interests in mind.
Why This Matters
Many families still assume inherited IRAs can remain untouched for decades. Under current law, that is rarely the case.
The combination of the 10-year rule, potential annual RMD requirements, and ordinary income taxation means beneficiaries must be intentional. Without a strategy, heirs may face unnecessary taxes or penalties.
A thoughtful plan can help preserve more of the account’s value for the next generation while remaining compliant with current regulations.
If you have inherited an IRA or want to review how your retirement accounts may impact your children, we encourage you to schedule a conversation with our team. We can help you evaluate your distribution options, understand the tax implications, and coordinate a strategy that aligns with your overall financial plan.
A Tax-Smart Way to Support What Matters Most
A Qualified Charitable Distribution is more than just a gift. It’s a strategy that allows you to align your financial goals with your personal values, all while managing your tax picture in retirement.
At Trinity Wealth Management, we specialize in helping retirees make the most of opportunities like QCDs. If you’re wondering whether this strategy fits into your retirement and charitable giving plans, we’d love to help. Contact us to explore how QCDs can be part of your financial plan.
Stay Ahead with Expert Guidance
Sources:
1RMDs begin at age 75 for those born January 1, 1960 or later
2Exceptions to the 10-year rule include: surviving spouse, minor children of the decedent, those critically ill or disabled, and those not more than 10 years younger than the original account holder.
Trinity Wealth Management is a registered investment advisor. The information provided in this article is for educational purposes only and should not be construed as personalized investment, tax, or legal advice. Annuity guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company, not by any federal agency. Past performance is not indicative of future results. Please consult with a qualified professional regarding your specific situation.