How to buy an annuity: the steps, the checks, and the costs

Buying an annuity is a sequence of decisions rather than a single purchase. You decide what job the money has to do, choose the product type that does that job, price the contract properly, check who stands behind the guarantee, and only then sign — with a free-look period still available if you change your mind. Skipping straight to a quoted rate is how people end up with a contract that pays well and does the wrong thing.

The order matters more than most sales conversations suggest. An annuity is a long-dated contract with an insurance company, and the features that decide whether it suits you are usually the ones that never appear on the front page of the brochure: the surrender schedule, the definition of the guaranteed rate, the treatment of the money at death, and the tax character of what comes out. This article walks the purchase in the order I would take it.

Step one: decide what job the annuity is doing

There are only a few things an annuity does well, and they are quite different from each other.

It can turn a lump sum into income you cannot outlive. It can hold money at a contractually guaranteed interest rate for a set number of years. It can give market-linked growth with some downside protection, at the cost of a cap on the upside. And it can defer tax on investment growth once other tax-advantaged accounts are full.

Write down which of those you want before you look at a single quote. If the answer is "guaranteed income starting now", you are looking at a single premium immediate annuity. If it is "a safe place for cash at a fixed rate for five years", you are looking at a MYGA. If it is "some market participation without full exposure", you are in indexed or registered index-linked territory. These are not variants of one product. They behave differently, cost differently, and fail differently.

A related question worth settling early: how much of your money should go in? Annuities are illiquid by design. Most buyers should keep an accessible cash reserve entirely outside the contract, and treat the annuity as covering a defined slice of spending rather than the whole portfolio.

Step two: match the product type to the job

Once the job is defined, the shortlist gets short quickly.

If you want	The usual product	The main trade-off
Income starting immediately, for life	Immediate annuity (SPIA)	Irreversible; you give up access to the capital
Income starting years from now	Deferred income annuity or QLAC	Long wait; usually no liquidity in between
A guaranteed rate for a fixed term	MYGA / fixed annuity	Rate is fixed; surrender charges apply if you leave early
Index-linked growth with full downside protection	Fixed index annuity	Caps and participation rates limit the upside
Index-linked growth with partial protection	Registered index-linked annuity	You keep some market loss below the buffer
Market investment inside a tax-deferred wrapper	Variable annuity	Layered fees; full market risk unless riders are added

The comparison that trips people up is between a fixed annuity and a bank certificate of deposit. They look alike and are not: one is a bank deposit with federal deposit insurance, the other is an insurance contract with a different backstop entirely. That distinction becomes step four.

Step three: work out what it actually costs

Some annuities have visible fees and some do not, and the ones that do not are often the ones where the cost is hardest to see.

On a fixed annuity or MYGA, there is usually no explicit annual charge. The insurer earns a spread between what it makes on its bond portfolio and the rate it credits you. The cost is real but invisible; the way to judge it is to compare the credited rate against what you could get elsewhere for the same term and the same credit quality, not to hunt for a fee line.

On a variable annuity, the costs are explicit and stack: a mortality and expense charge, an administrative charge, the underlying fund expenses, and a separate charge for each optional rider. Add them up as one number before comparing anything.

Then there is the cost of leaving early. Almost every deferred annuity carries a surrender charge that declines over a set number of years, and many fixed contracts add a market value adjustment on top, which can move the payout up or down with interest rates at the time you withdraw. Ask for the full surrender schedule year by year, in writing, and read it against your own likely need for the money. Our guide to annuity fees and surrender charges sets out how these interact.

One habit worth adopting: ask the person selling the contract how they are paid, and whether the compensation differs across the products they have shown you. It is a fair question and the answer is informative.

Step four: check who stands behind the guarantee

An annuity guarantee is only as good as the company making it. Annuities are not FDIC-insured, and there is no federal backstop for insurer failure.

What exists instead is three layers. State insurance departments regulate insurer solvency, including statutory reserve and risk-based capital requirements. If an insurer is placed in liquidation, policyholder claims rank ahead of general creditors in the estate. And every state, plus the District of Columbia and Puerto Rico, has a life and health insurance guaranty association that covers annuity contracts up to a statutory limit set by that state — coverage comes from your state of residence, and the limits vary meaningfully between states.

Two practical checks follow. First, look at the issuing company's financial strength ratings from the independent rating agencies, and at how long it has been writing the product you are buying. Second, if the amount you are placing is large relative to your state's guaranty association limit, consider splitting it across two insurers, because the limit applies per insurer. The same reasoning applies to structured settlement annuities, and the mechanics are set out in more detail in what happens if the insurance company fails.

Step five: read the contract, then use the free-look period

The illustration is marketing. The contract is the agreement. Where they disagree, the contract wins.

Three things to find in the document itself. What exactly is guaranteed, and for how long — a headline rate that applies for one year on a ten-year contract is a different product from one guaranteed for the full term. What happens at death, and to whom. And what you can withdraw without penalty, which on many deferred contracts is a defined annual percentage of the account value.

Every state requires a free-look period after delivery, commonly ten days or longer depending on the state and product, during which you can cancel and get your money back. That window exists precisely so you can read the contract without pressure. Use it. If the contract does not match what you were told, that is the moment to act, not later.

Where you buy it, and how it gets funded

Annuities are sold through insurance agents, broker-dealers and their registered representatives, banks, and in some cases directly by the insurer. Fixed and indexed annuities are insurance products regulated by state insurance departments. Variable and registered index-linked annuities are also securities, registered with the SEC and sold with a prospectus by a licensed representative.

Sales conduct is regulated on both tracks. The NAIC revised its Suitability in Annuity Transactions Model Regulation in 2020 to impose a best-interest standard on annuity recommendations, and the great majority of states have since adopted it; recommendations of variable annuities by broker-dealers also fall under FINRA rules and the SEC's Regulation Best Interest. None of that removes the buyer's own work, but it does mean you are entitled to a documented explanation of why this contract was recommended to you.

Funding matters for tax. Money moved from an IRA or a 401(k) into an annuity keeps its qualified status if it goes as a direct transfer or direct rollover; the resulting contract is a qualified annuity, and withdrawals are generally fully taxable as ordinary income. Money from a taxable account buys a non-qualified annuity, where only the earnings are taxable and your original after-tax contribution comes back untaxed. That difference is explained in how annuities are taxed. If you are replacing an existing non-qualified annuity with a new one, a 1035 exchange can move the money without triggering tax — but the money must go company-to-company, never through your hands.

Mistakes that come up repeatedly

Buying on the headline rate alone, without reading how long the rate is guaranteed. Putting in more than you can afford to lock away, then paying surrender charges to get it back. Buying a lifetime income rider and never using it. Assuming an annuity inside an IRA adds tax deferral — it does not; the IRA already provides it, so the annuity has to earn its place on its guarantees alone. And treating a fixed-term payout as lifetime income when it is not.

If you want to sanity-check the income a given premium might produce before you talk to anyone, our annuity payout calculator gives an illustrative figure based on assumptions you set. It is a rough guide for framing the conversation, not a quote.

Any rate, payout, or charge you see in an illustration is a point-in-time figure. Rates and product terms change; verify the current numbers with the issuing insurer before acting on anything.

Frequently asked questions

How long does buying an annuity take?

The application itself is usually straightforward, and funding is what sets the timetable. A transfer of cash can complete in days. A direct transfer from an existing IRA or another annuity contract typically takes a few weeks, because it depends on the releasing institution. Immediate annuities generally start paying one payment interval after the contract is issued.

Can I change my mind after signing?

Yes, within the free-look period, which every state requires and which commonly runs ten days or longer from delivery of the contract. Cancel within that window and you get your money back without surrender charges. After it closes, exiting means surrender charges and possibly a market value adjustment.

Do I need a financial adviser to buy one?

No, but the contract is long-dated and hard to unwind, so a second opinion from someone who is not paid on the sale is worth having. An accountant or fee-only planner can check how the purchase interacts with your tax position, your other retirement accounts, and your liquidity, which is where most avoidable mistakes sit.

Is it better to buy one annuity or several smaller ones?

Splitting has two advantages: it spreads exposure across insurers, which matters because guaranty association limits apply per insurer, and it lets you stagger start dates or terms rather than committing everything at one set of rates. The trade-off is more paperwork and sometimes weaker pricing on smaller premiums.

This article is educational and not personal financial advice. Your own tax position, state law, and the terms of any specific contract will determine the right answer for you; check them with a qualified adviser before acting.