How Much Does an Annuity Actually Cost?

Fees can include underwriting, fund management, and withdrawal penalties

Reviewed by Ebony HowardFact checked by Ryan EichlerReviewed by Ebony HowardFact checked by Ryan Eichler

Annuities might have looked like an ideal retirement vehicle at one time, but they have have lost some of their glow. There are several reasons for this, including:

• Market performance
• The fine print on returns
• Hidden costs

With annuities, you should be wary of the fees buried in the fine print. Discover the true cost of an annuity here.

Key Takeaways

• Annuities are financial products that provide you with a steady, fixed stream of income in the future, usually during retirement.
• Their popularity has dropped primarily because of market performance, the fine print on returns, and their hidden fees.
• Fees can include underwriting, fund management, and penalties for withdrawals prior to age 59½, among others.
• These retirement vehicles may still be attractive because record-keeping requirements are light, taxes on earnings are deferred, and there are no investment limits.
• The SECURE Act also allows investors to invest in annuities via their 401(k).

Annuity Fees

Here are a few of the fees that can be buried deep within an annuity contract—or not shown at all:

• Commission: An annuity is basically insurance, so some salesperson gets a cut of your return or principal for selling you the policy.
• Underwriting: These fees go to those who take actuarial risk on the benefits.
• Fund management: If the annuity invests in a mutual fund, as most do, the management fees are passed onto you.
• Penalties: If you are under age 59½ and need to make withdrawals, the Internal Revenue Service (IRS) gets 10% and the contract writer nets a surrender charge between 5% and 10%. Keep in mind that this charge often drops the longer you hold the annuity. Other contract writers have declining surrender fees at a lower percentage and allowances for 5% to 15% emergency withdrawals without penalties.
• Tax opportunity cost: After-tax dollars that you invest in an annuity grow tax-deferred. However, the benefits cannot compete with putting pre-tax dollars into your 401(k). Annuities should begin only where your 401(k) ends, once you’ve maxed out on contributions. This is even more true if your employer is matching contributions.
• Taxes on beneficiaries: If you leave your mutual fund to your kids, the IRS allows them to take advantage of a step-up valuation, or the market price of the securities at the time of transfer. This doesn’t work with annuities, so your beneficiaries are likely to be charged taxes at the gain from your original purchase price.

Important

If you want to transfer funds to another insurance company without penalty, let your accountant handle the transaction—receiving the check yourself could cause trouble.

Reasons to Invest in Annuities

After all the downsides and hidden costs, there are still a few upsides:

• No heavy record-keeping requirements
• Deferred taxes on your growing money
• Tax-free transfers between annuity companies
• No investment limits
• Can invest in annuities via 401(k)s thanks to the SECURE Act

What Are Annuities?

Annuities are insurance contracts that pay a fixed stream of income to investors in the future. The participant must make only three decisions:

• Lump-sum or periodic contributions
• Deferred or immediate income
• Fixed or variable returns

How Do Annuities Work?

Annuities are financial products that allow investors to put aside a lump-sum deposit or periodic payments to use as income in the future. Investors can choose between deferred or immediate income and fixed versus variable returns. The money set aside grows over time. But there are fees involved, including commissions and taxes. And there are penalties you pay if you decide to make early withdrawals.

What Are the Different Types of Annuities?

There are several different types of annuities. Deferred annuities begin paying out after a certain amount of time has elapsed while immediate annuities start to pay the investor income after they deposit a lump sum of money. Fixed annuities provide consistent payments to the investor over the life of the contract. On the other hand, variable annuities pay the investor larger sums when the fund does well and smaller payments when they do poorly.

Is an Annuity a Good Investment?

The answer depends on you and your personal situation. As with any investment, there are pros and cons to annuities. They provide a steady stream of income for investors later in life, usually during retirement, and are well-suited for people who don’t want to deal with the intricacies that come with investing. But there are some drawbacks to these products. For instance, there are hidden fees that take away from any returns you may generate, including commissions, underwriting fees, and taxes.

The Bottom Line

After considering all the pros and cons, it’s important to remember that your entire investment in an annuity—or much of it—can be lost if the company behind the contract isn’t sound.

There are some state protections for some annuity funds, but they are limited, so make sure you do your research. You can buy annuities below your state’s protection limit from several companies instead of buying one larger annuity from a single company. But if you move from a state with a high limit to one with a lower limit, your new state’s level will generally apply should the annuity fail after you move.

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