10 Questions to Ask Before You Buy an Annuity

What type of annuity is this, and why is it right for me?

There are five main annuity categories — fixed, fixed-indexed, variable, immediate, and deferred income — and each is designed for a fundamentally different purpose. A fixed annuity is built for predictable, guaranteed accumulation. A fixed-indexed annuity offers principal protection with growth potential tied to a market index. A variable annuity grows with market investments but carries full market risk. An immediate annuity converts a lump sum into income that starts within a month. A deferred income annuity locks in income that starts at a future date, often used as longevity insurance.

Before accepting a recommendation, you need to understand which category you are being sold and how that category matches your specific situation: your age, income timeline, risk tolerance, existing assets, and how much liquidity you need to preserve. A good advisor will articulate this connection clearly. If the explanation relies entirely on product features without referencing your personal financial picture, that is a signal to push harder.

What are all the fees — and how do they compound?

Annuity fees vary widely by product type and are often expressed as annual percentages that look small in isolation but compound into substantial costs over a 10- or 20-year holding period. Fixed annuities typically have no explicit ongoing fees — the insurer’s margin is built into the credited rate. Fixed-indexed annuities may carry rider fees of 0.5% to 1.5% per year charged against the account value. Variable annuities layer in mortality and expense charges (typically 1.0% to 1.5% per year), underlying fund expenses (0.5% to 2.0%), and optional rider fees on top of that — total annual costs in some variable annuity products exceed 3.5%.

Ask for a complete fee disclosure, not just the headline figures. Then ask your advisor to project what your account value looks like at year 10 and year 20 with and without the fees. The difference is often striking — and it is the clearest way to evaluate whether the benefits of any optional riders justify their cost.

What is the surrender period and surrender charge schedule?

Most deferred annuities impose a surrender period — a set number of years during which you cannot withdraw your principal without paying a penalty. Surrender charges typically start at 7% to 10% in year one and decline by one percentage point per year, reaching zero by the end of the surrender period. Common surrender periods run 5 to 10 years, but some products stretch to 14 years.

During the surrender period, the only penalty-free access to your money is usually a free withdrawal provision — commonly 10% of the account value per contract year. Anything above that amount is subject to the surrender charge. Beyond the carrier’s penalty, the IRS imposes a 10% early withdrawal penalty on gains taken before age 59½, on top of ordinary income tax owed on the amount withdrawn.

Understand the surrender schedule as a liquidity commitment. If there is any meaningful chance you will need more than 10% of this money in the next five to ten years — for a health event, a home purchase, or a major family expense — that probability should factor directly into your purchase decision.

What riders are included, and what do they actually cost?

Riders are optional (and sometimes automatic) contract provisions that add specific benefits — lifetime income guarantees, enhanced death benefits, long-term care provisions, return-of-premium protections, and others. The most commonly sold rider is the guaranteed lifetime withdrawal benefit (GLWB), which allows you to take a fixed percentage of a “benefit base” each year for life, regardless of actual account performance.

The critical detail is that the benefit base — the number your income percentage is applied to — is not the same as your actual account value. It is a notional figure used only to calculate your income amount and cannot be withdrawn as a lump sum or passed to heirs. Many buyers do not understand this distinction until they attempt to access their money. Ask your advisor to explain the difference between the account value, the benefit base, and the surrender value, and to show you a side-by-side illustration with the rider and without it.

How is my money invested, and what are the caps, floors, and participation rates?

In a fixed annuity, your premium earns a declared interest rate guaranteed for a set period. In a fixed-indexed annuity, your credited interest is linked to an external index — most commonly the S&P 500 — subject to three key parameters: the cap rate (maximum interest you can be credited in a period), the floor (minimum, often 0%, meaning you cannot lose principal), and the participation rate (the percentage of index gains you receive before the cap is applied). A product with a 6% cap, 0% floor, and 100% participation rate means if the S&P 500 gains 15%, you earn 6%; if it loses 20%, you earn 0%.

These parameters are not guaranteed forever. Cap rates are typically reset annually and have trended downward in the low-rate environment of the past decade. Ask what the current cap is, what the contractual minimum cap is (often as low as 1% to 2%), and what the historical cap trend has been for this carrier and product. Also ask whether the crediting method uses a point-to-point calculation, monthly averaging, or another method — the method matters as much as the cap.

What is the financial strength rating of the insurance company?

An annuity is only as secure as the insurance company behind it. Unlike bank deposits, annuities are not FDIC-insured. They are backed by the general account assets of the issuing insurer and, secondarily, by each state’s guaranty association — which provides limited protection (typically $100,000 to $500,000 in contract value, varying by state) if the carrier becomes insolvent.

Before purchasing, look up the carrier’s financial strength rating from at least two of the major rating agencies: A.M. Best, Moody’s, Standard & Poor’s, and Fitch. Look for ratings of A or better (A.M. Best’s scale runs from A++ down to D). An A-rated carrier has demonstrated long-term financial stability and reserve adequacy. Avoid carriers rated below B+ without a compelling reason and expert counsel.

For large premium amounts — $500,000 or more — your advisor may recommend splitting the premium across two or more highly rated carriers to maximize guaranty association coverage in your state.

How is the income payment calculated, and when does it start?

If your goal is guaranteed income — which is the primary reason most people buy annuities — the mechanics of the income calculation deserve careful scrutiny. For immediate annuities and deferred income annuities, the payout is calculated at purchase based on your age, gender, premium amount, and prevailing annuity rates. For deferred annuities with income riders, income is typically calculated as a percentage of the benefit base — often 4% to 6% per year depending on your age when you activate income.

Ask for a specific income illustration that shows: the monthly income amount you would receive, the age at which you must activate income to receive that amount, whether the income adjusts for inflation or is fixed, and whether income continues for your spouse if you die first (joint life payout). Also ask whether income payments reduce the death benefit payable to your heirs, and what happens to the contract if you die before activating income.

What happens to my money when I die?

Annuity death benefits vary significantly by product type and structure. In a deferred annuity, if you die before annuitization, the standard death benefit is typically the greater of the account value or the sum of premiums paid (return of premium). Some products offer an enhanced death benefit rider that locks in the highest account value reached on contract anniversaries, providing a higher floor for your heirs.

If you have annuitized — meaning you have exchanged your account value for a stream of income payments — what happens at death depends on the payout option selected. A life-only payout stops at your death regardless of how long you lived or how much you received. A life with period certain payout continues payments to your beneficiary for the remainder of the guaranteed period. A joint and survivor payout continues reduced payments to a surviving spouse for their lifetime. Each option produces a different monthly income amount; the tradeoff between income and heir protection is yours to make, but you need to understand each option clearly before choosing.

What are my options if my needs change?

Financial plans shift. Health changes, family situations evolve, interest rates move, and better products may become available during a long surrender period. Ask specifically what your options are if circumstances change materially after you purchase. Most contracts allow penalty-free withdrawals of up to 10% of the account value per year, a useful but limited safety valve. Some carriers offer a nursing home or terminal illness waiver that removes surrender charges if you are confined to a care facility or diagnosed with a terminal condition — ask whether this contract includes such provisions and exactly what qualifies.

Also ask about 1035 exchanges — an IRS provision that allows you to move from one annuity contract to another without a taxable event, as long as the exchange is executed correctly. A 1035 exchange can be a useful tool if a significantly better product becomes available after your surrender period ends, but it restarts the holding clock on the new contract. Understanding this option before you need it means you will not be surprised by it later.

Are you a fiduciary, and how are you compensated for selling this?

This is the question most buyers hesitate to ask — and the one that matters most when evaluating the advice you receive. A fiduciary advisor is legally required to act in your best interest. A non-fiduciary advisor operating under a suitability standard is only required to recommend products that are “suitable” — a meaningfully lower bar. Many annuity sales are made by insurance agents who are not fiduciaries and who earn commissions of 4% to 8% of the premium amount at the time of sale, with no ongoing advisory relationship.

Neither arrangement is inherently bad. Commissioned insurance agents provide legitimate access to products that fee-only advisors may not offer. But you deserve to know the compensation structure before you decide how much weight to give the recommendation. Ask directly: Are you a fiduciary? What commission do you earn if I purchase this product? Do you earn more for recommending this product than an alternative? A professional who is genuinely acting in your interest will answer these questions without hesitation.