An annuity adds no extra tax advantage inside an IRA or 401(k), and gains taken out of any annuity are taxed as ordinary income, not at capital gains rates (FINRA, Annuities, checked October 14, 2026).
An annuity is an insurance contract first
FINRA describes an annuity as "a contract between you and an insurance company" in which the company promises to make payments to you, now or later (FINRA, Annuities, checked October 14, 2026). That is the honest starting point. You are buying a set of promises, and each promise has a price.
Annuities are popular. Americans bought $464.1 billion of them in 2025 (LIMRA, Preliminary U.S. Annuity First Quarter 2026 Sales Estimates, 2026). Popularity tells you they are heavily sold. It does not tell you whether one fits you.
The sales pitch usually sounds like this: safe growth, market gains with no losses, income you cannot outlive. The contract says something narrower. Growth may be capped. The guarantees depend on the insurer staying in business. Your money is tied up for years, and the insurer may be able to change rates and caps after the first term.
So the better question is not "is this a good investment?" It is "is this promise worth what I give up to get it?"
The real costs: access, fees, commissions and taxes
Access. Most deferred annuities charge a surrender fee if you take out more than a free amount in the early years. The SEC gives a typical example of 7% in the first year, falling by one point a year until it disappears in the eighth year (SEC, Variable Annuities: What You Should Know, page modified April 18, 2011). FINRA notes variable annuities can have surrender periods of eight years or more (FINRA, Annuities, checked October 14, 2026). See surrender charges.
Fees. Variable annuities charge a mortality and expense risk charge, typically about 1.25% a year, plus administrative fees typically about 0.15% a year, before fund expenses and optional riders (SEC, Variable Annuities: What You Should Know, page modified April 18, 2011). Fixed and indexed annuities usually show no annual fee, but the cost is built into the rate, cap or spread you are offered. See annuity fees.
Commissions. The seller is usually paid by the insurer. The latest public industry averages we could verify put the agent commission on indexed annuities at 6.26% of premium, against 2.29% on multi-year guaranteed annuities, for the first quarter of 2018 (InsuranceNewsNet, citing Wink, May 25, 2018). More in our annuity commissions research.
Taxes. The taxable part of an annuity withdrawal is ordinary income (IRS, Publication 575, 2025), even when the growth was linked to stocks. Taxable money taken before age 59½ can owe an extra 10% tax (IRS Publication 575, 2025). Heirs do not get a step-up in basis on the gain. See how annuities are taxed.
When an annuity can make sense
To be fair, annuities do some things nothing else does.
- Income you cannot outlive. An immediate or deferred income annuity turns savings into a paycheck for life. For someone worried about living to 95, that is real insurance. See immediate annuities.
- A guaranteed rate for a set term. A multi-year guaranteed annuity works much like a CD from an insurer, with tax deferral outside retirement accounts. See MYGAs explained.
- Tax deferral after retirement plans are full. FINRA says most investors should think about annuities only after they have maxed out their before-tax retirement plans (FINRA, Annuities, checked October 14, 2026).
- Protection from a market drop for money you will not need for the full surrender period.
In each case the annuity earns its place by covering a specific risk, not by beating other investments.
Who should usually not buy one
- People who may need the money within the surrender period, or who have no separate emergency fund.
- People buying inside an IRA or 401(k) for tax deferral, which they already have.
- People who want low-cost market growth and do not need a guarantee. The guarantee is the product; if you do not need it, you are paying for something you will not use.
- People who mainly want to leave the money to heirs, since gains pass with income tax due and no step-up. See inherited annuity taxes.
- Anyone who cannot explain, in their own words, how the contract credits interest and what it costs to leave early.
How to check before you sign
Since February 2020 the model rule written by the National Association of Insurance Commissioners (NAIC) says annuity recommendations must be in the consumer's best interest, and 40 states had adopted it as of November 1, 2023 (NAIC, Annuity Suitability and Best Interest Standard, November 1, 2023). Ask the seller to show you, in writing, why this product beats the alternatives for you.
Before you sign, look up the company and the person. Your state insurance department licenses both; find yours through the NAIC list of state insurance departments. The NAIC Consumer Insurance Search shows complaint information on insurers. If the product is a variable annuity or a registered index-linked annuity, the seller must also be registered with FINRA, which you can check on FINRA BrokerCheck.
After delivery you have a free-look period to cancel without surrender charges. Its length is set by your state and generally runs 10 to 30 days (FINRA, Annuities, checked October 14, 2026). See how the free-look period works.
A plain example with numbers
Hypothetical: a married couple with $900,000 saved puts $300,000 of it (not IRA money) into a deferred annuity with a 7-year surrender schedule like the SEC example (7% in year 1, 6% in year 2, 5% in year 3). In year 3 the contract is worth $318,000 and they need $90,000 to help a child buy a home.
| Step | Amount |
|---|---|
| Withdrawal needed | $90,000 |
| Free withdrawal allowed (10% of $318,000) | $31,800 |
| Amount above the free amount | $58,200 |
| Surrender charge (5% of $58,200) | $2,910 |
| Taxable gain, comes out first ($318,000 minus $300,000) | $18,000 |
| Federal tax at a hypothetical 22% bracket (22% of $18,000) | $3,960 |
| Total cost of getting their own money early | $6,870 |
Arithmetic: $2,910 + $3,960 = $6,870. The contract may also apply a market value adjustment, which can raise or lower this. The free amount, schedule and adjustment are in the contract; the 10% free amount here is a common design, not a rule. Gains coming out first on non-qualified contracts is IRS treatment for contracts issued after August 13, 1982 (IRS Publication 575, 2025).
The $18,000 is ordinary income in the year it comes out, on top of pensions, Social Security and required distributions. For couples near a Medicare premium line, that matters; see how IRMAA works.
Red flags
- Calling an annuity a "safe investment" or "like a CD" without showing you the surrender schedule in writing.
- Promising "market gains with no losses" without telling you the cap, participation rate or spread, and that it can change.
- Recommending an annuity inside your IRA because of "tax-deferred growth", which the IRA already gives you.
- Suggesting you put most or all of your savings into one contract.
- Pushing a bonus as free money without showing the longer surrender period or lower cap that pays for it.
- Pressure to sign today because a rate or bonus "ends Friday".
- Describing guarantees without naming the insurer or explaining that they depend on its ability to pay.
- Refusing to say, in dollars, how the seller is paid on this sale.
- Suggesting you cash out an older annuity to buy a new one with a fresh surrender period.
- Telling you that annuity gains are taxed like capital gains.
Questions to ask before you sign
- What exactly is guaranteed, in dollars, and what is only illustrated?
- How long is the surrender period, and what is the charge in each year?
- How much can I take out each year with no charge?
- Is there a market value adjustment, and how could it change what I get back?
- What are all the annual fees and rider charges, as percentages and in dollars?
- Can the insurer lower the cap, participation rate or crediting rate after the first year, and what is the guaranteed minimum?
- How are you paid on this sale, and what would you earn on a simpler or shorter contract?
- Why is this better for me than a CD, a Treasury, or leaving the money where it is?
- How will withdrawals be taxed, and what will my heirs owe?
- How long is my free-look period, and how do I cancel in writing?
Read This Before You Sign
A one-page checklist: the red flags in annuity and indexed universal life (IUL) sales, and the questions to ask before you sign anything. A one-page list of questions to ask before buying any annuity, plus where to check the seller and insurer. We’ll email it to you.
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Sources
- FINRA: Annuities (checked October 14, 2026)
- SEC: Variable Annuities: What You Should Know (page modified April 18, 2011, checked October 14, 2026)
- LIMRA: Preliminary U.S. Annuity First Quarter 2026 Sales Estimates (2026, checked October 14, 2026)
- IRS: Publication 575 (2025), Pension and Annuity Income (checked October 14, 2026)
- InsuranceNewsNet, citing Wink's Sales & Market Report: agent commissions, first quarter 2018 (May 25, 2018)
- NAIC: Annuity Suitability and Best Interest Standard (updated November 1, 2023)
- NAIC: Consumer Insurance Search (checked October 14, 2026)
The Retirement Literacy Foundation is a 501(c)(3) public charity. This page is general education, not tax, legal or investment advice. Nothing is sold here, no product is recommended, and RLF accepts no funding from financial companies. Rules and figures change; each one above shows its source and date. Check anything you plan to act on with your state insurance department or a qualified professional who is not paid on the product.