Before you sign an annuity contract, the questions to ask about annuities before you buy fall into nine areas: fees, surrender charges, your free look window, how your money grows, taxes, payout options, death benefits, replacement rules if you already own one, and the insurer’s financial strength. Each area is where buyers most often get surprised, and each answer should come to you in writing.
What Will This Annuity Actually Cost Me Each Year?
Ask for a written breakdown of every charge in the contract, not a summary. Fees compound over decades, and the structure varies by product type.
Variable annuities carry a mortality and expense (M&E) risk charge that typically runs about 1.25% of account value per year. Some contracts run higher. Ask for the exact percentage and whether it can change over the life of the contract. Administrative fees come on top, often as a flat annual charge or a small percentage of your balance. Optional riders like guaranteed minimum income benefits or enhanced death benefits can add another 1% or more per year each. Stacking three or four riders can quietly eat your returns.
Ask the agent directly how they get paid. Commissions are built into the product’s pricing rather than deducted from your balance, but they still shape what the insurer can offer you. Higher-commission products tend to come with longer surrender periods and less favorable terms, so knowing the commission structure helps you judge whether the recommendation fits your needs or the payout.
How Hard Is It to Get My Money Out?
Surrender charges are the penalties for pulling money out before a set period expires, and this is where annuities differ most sharply from bank accounts or brokerage portfolios.
Surrender periods on most annuities run six to eight years, though some stretch to ten.1Investor.gov. Surrender Charge Early withdrawals during that window trigger a penalty that starts as high as 7% of the amount withdrawn and decreases by roughly a percentage point each year until it hits zero. Ask for the full surrender schedule in writing so you can see the penalty in each contract year.
Most contracts include a free withdrawal provision that lets you take out a portion each year without triggering the charge, commonly 10% of the contract value. Ask whether that percentage is based on your original premium or the current account value, because the difference grows as the account grows. Then ask what happens if you need more in an emergency. Some insurers offer hardship waivers for nursing home stays or terminal illness, but those provisions vary by contract.
How Long Is the Free Look Period in My State?
Every state requires insurers to give you a window after the contract is delivered during which you can cancel for a full refund with no surrender charge. The free look period typically runs at least 10 days from the date you receive the contract, though many states require longer windows of up to 30 days.2Investor.gov. Variable Annuities – Free Look Period The NAIC’s model regulation calls for a minimum 15 days when the buyer’s guide and disclosure documents were not provided at or before application.3National Association of Insurance Commissioners. Annuity Disclosure Model Regulation
Ask exactly how many days your state allows and when the clock starts. The countdown runs on calendar days, not business days. If you have any doubts after reading the full contract at home, this is your exit window, and it is the only penalty-free exit you will get for years.
How Does the Money Actually Grow?
A vague answer here should be a dealbreaker. The crediting method determines whether your returns are guaranteed, partially protected, or fully exposed to market swings.
Fixed Annuities
A fixed annuity pays a guaranteed interest rate for an initial period, often two to five years. Ask what happens when that period ends. The insurer resets your rate based on its current investment portfolio and prevailing interest rates, which could be significantly lower than the opening rate. Ask whether the contract includes a bailout provision that lets you surrender without penalty if the renewal rate falls below a stated floor. Also confirm the minimum guaranteed rate that applies for the life of the contract. That is your worst case.
Fixed Index Annuities
Indexed products tie your returns to a market index like the S&P 500, but you do not directly own stocks. Gains are limited by a cap (the maximum interest you can earn in a given period), a participation rate (the percentage of the index’s gain credited to you), and sometimes a spread or asset fee deducted before anything is credited. Ask for all three numbers. A 6% cap sounds fine until a 20% market year nets you only 6%. Ask whether the cap and participation rate are guaranteed or adjustable, because many are reset annually.
Variable Annuities
Variable annuities let you invest in sub-accounts that function much like mutual funds, holding stocks, bonds, or a mix of both.4U.S. Securities and Exchange Commission. Variable Annuities Your principal is directly exposed to market losses. Ask about the internal management fees on each sub-account, which sit on top of the M&E and administrative fees. A variable annuity with combined annual costs of 3% or more needs consistently strong performance just to keep pace with simpler investments.
Registered Index-Linked Annuities
RILAs split the difference between indexed and variable products, using a buffer or a floor to limit market losses. A 10% buffer means the insurer absorbs the first 10% of losses, and you bear losses beyond that. A floor caps your maximum loss at a set percentage. Higher protection lowers your upside cap. Ask whether the contract uses a buffer or a floor, what the crediting period is (often one or two years), and whether gains are locked in at the end of each period.
What Are the Tax Consequences?
The IRS treats annuity earnings as ordinary income rather than capital gains. Your tax rate on withdrawals could be significantly higher than on a stock portfolio held in a taxable account.
The 10% Early Withdrawal Penalty
If you take money from an annuity before age 59½, the IRS imposes a 10% additional tax on the taxable portion of the distribution. The penalty applies on top of regular income tax and on top of any surrender charge the insurer imposes.5Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts A handful of exceptions exist: distributions after the owner’s death, distributions due to disability, and a series of substantially equal periodic payments spread over your life expectancy can avoid the penalty.6Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions Ask your agent to walk through the tax math on any scenario where you might need money before 59½.
Qualified vs. Non-Qualified Treatment
Tax treatment depends on whether the annuity sits inside a qualified retirement account (like a 401(k) or traditional IRA) or was purchased with after-tax dollars. In a qualified annuity, the entire distribution is taxed as ordinary income. In a non-qualified annuity, only the earnings portion is taxed; your original premium comes back tax-free under an exclusion ratio.5Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts Ask which category this annuity falls into, because the distinction shapes every withdrawal decision.
Required Minimum Distributions
If you hold the annuity inside a qualified retirement plan, you must begin taking required minimum distributions at age 73. That threshold rises to 75 for people who turn 73 after December 31, 2032.7Congress.gov. Required Minimum Distribution (RMD) Rules for Original Owners Missing an RMD triggers a steep excise tax. Ask how the contract coordinates with RMD rules, especially if annuity payments have already begun and may or may not satisfy the annual requirement.
What Are My Payout Options When Income Starts?
Once you choose a payout structure, the choice is usually irreversible.
Annuitization or Systematic Withdrawals
Annuitization converts your balance into a guaranteed income stream. You give up access to the lump sum in exchange for payments that last a set period or for life. Systematic withdrawals let you pull money out on a schedule while keeping control of the remaining balance, but the payments are not guaranteed to last forever. Ask which approach the contract supports and whether switching to annuitization later is possible.
Life Only, Period Certain, or Both
A life-only payout delivers the highest monthly check because the insurer stops paying when you die, even if that is a year into the payout. A period-certain option guarantees payments for a fixed duration, such as 10 or 20 years, and continues paying your beneficiary if you die before the period ends. A life-with-period-certain option combines both. Each involves a tradeoff between the size of the monthly payment and the protection it offers your family.
Spousal Protections
If you are married and the annuity is inside a qualified retirement plan, federal law requires the plan to offer a qualified joint and survivor annuity (QJSA). The surviving spouse continues receiving between 50% and 100% of the payment amount after your death.8Internal Revenue Service. Retirement Topics – Qualified Joint and Survivor Annuity You can waive the QJSA only with your spouse’s written consent. Outside qualified plans, most insurers still offer joint-and-survivor options. Ask about the reduction percentage. A survivor payment of 50% might not cover household expenses that remain after one spouse dies.
Inflation Protection
A fixed monthly payment that feels comfortable today loses purchasing power over a 25-year retirement. Some contracts offer a cost-of-living adjustment (COLA) rider that increases payments by a fixed percentage each year, but it reduces your initial payment and adds cost. Ask what the annual increase percentage is, how it is calculated, and what the starting payment would be with and without the COLA. Seeing both numbers side by side makes the tradeoff concrete.
What Happens to the Annuity When I Die?
The standard death benefit returns either the current account value or the total premiums you paid, whichever is greater. Enhanced death benefit riders can lock in the highest historical account value or guarantee a minimum growth rate for your heirs, at the cost of an annual fee.
Ask exactly how the death benefit is calculated and when it resets. Some enhanced riders lock in the high-water mark only on specific anniversary dates, so a spike between anniversaries goes uncaptured. Also ask whether the death benefit still applies if you have annuitized the contract, because many annuitization options eliminate the death benefit once payments begin.
Beneficiaries generally owe ordinary income tax on the earnings portion of any payout from a non-qualified annuity and on the entire amount from a qualified annuity. For qualified accounts where the owner died after 2019, the original SECURE Act requires most non-spouse beneficiaries to empty the inherited account within 10 years, which can push them into higher tax brackets.9Internal Revenue Service. Retirement Topics – Beneficiary Surviving spouses have more flexibility. Ask how these rules interact with the specific contract and coordinate the beneficiary designations with your broader estate plan.
Should I Replace an Annuity I Already Own?
If someone suggests swapping your current annuity for a new one, the questions change. Replacements generate fresh commissions, restart surrender periods, and can trigger taxes if structured badly.
A Section 1035 exchange lets you move from one annuity contract to another without recognizing taxable gain, as long as the owner stays the same on both contracts.10Office of the Law Revision Counsel. 26 U.S. Code 1035 – Certain Exchanges of Insurance Policies The exchange must be a direct transfer between insurers. If you cash out and then buy a new annuity, the entire gain becomes taxable. Partial exchanges can qualify, but withdrawing from either contract within 180 days of the exchange can cause the IRS to treat the transaction as a taxable distribution.
Ask the recommending agent to compare the surrender charges remaining on your current contract against the new surrender schedule, the differences in fees and crediting terms, and whether you are giving up benefits (like a favorable guaranteed minimum rate) the new contract does not match. All 50 states now require agents to act in your best interest when recommending annuity transactions, including replacements.11National Association of Insurance Commissioners. Annuity Suitability and Best Interest Standard They cannot put their financial interest ahead of yours, and they must document why the replacement benefits you. Ask to see that documentation.
How Strong Is the Insurer Behind the Contract?
An annuity is only as reliable as the company behind it. Annuities are not backed by the FDIC. The promises in your contract depend on the insurer remaining solvent for the next 20, 30, or 40 years.
Ask for the company’s credit ratings from A.M. Best, Moody’s, and Standard & Poor’s. A high rating is not a guarantee, but a low rating is a warning. If the agent cannot produce current ratings or brushes off the question, that tells you something on its own.
If an insurer does fail, every state operates a guaranty association that steps in to cover policyholders. The standard coverage limit for annuity benefits is $250,000 per person in most states, though a handful of states set higher limits.12National Organization of Life & Health Insurance Guaranty Associations. How You’re Protected If you are investing more than $250,000, splitting the amount across multiple highly rated insurers keeps each contract within the guaranty association’s coverage. Ask the agent about your state’s specific limit before committing a large sum to one company.