Buying an Annuity: A Step-by-Step Guide
Why it matters
- Right now, annuities could be a great alternative to a volatile stock market — one that takes advantage of higher interest rates.1
- Buying an annuity is more straightforward than you might think.
- If guaranteed lifetime income and tax-deferred growth sound appealing, you may want to consider an annuity.
An annuity is a long-term insurance contract that provides the opportunity to receive stable, guaranteed income for life. These contracts can offer tax-deferred growth, protection against market downturns, and a way to address the risk of outlasting savings. They can be a smart way to secure steady income in retirement. Also, annuities aren’t backed by the federal government; instead, they’re backed by the claims-paying ability of the insurance company.
What’s more, annuities are having a moment right now. The stock market’s current uncertainty is driving record annuity sales; in 2022, sales were expected to reach almost $300 billion, passing the $265 billion sold in 2008.1 If you haven’t considered them before, take a minute to learn how annuities work. In this article, we’ll go step by step through the process of buying one. It’s actually much easier than you might think.
Benefits of an annuity
First, let’s understand the more common reasons people buy annuities.
1. Premium protection in many cases. Unlike retirement accounts that invest in stock markets, many annuities can offer protection from market downturns.2 While it depends on your annuity contract, you typically can’t lose the money you’ve paid into it. That’s appealing to anyone who doesn’t want to weather market volatility, especially those in or nearing retirement.2
2. Guaranteed income. After you’ve finished paying for the annuity (via a lump sum or installments), you’ll start receiving regular, guaranteed payouts for a predetermined length of time or until the end of your life, depending on your contract.3
And while it may vary somewhat by annuity contract, you’ll most likely continue to receive a steady stream of income no matter how long you live.2 Even if you’ve lived long enough to have collected your entire premium and any earnings, the insurance company will continue to regularly pay you the same amount.2
3. Leave a legacy. By selecting a beneficiary, you can pass your annuity value on to a loved one. Doing so could also help avoid going through probate, something that can take time and money during a difficult period in the lives of your friends and family.2
4. Long term care. Recent research by the federal government suggests that most Americans turning 65 will need long term care at some point in their lives.4 You can help address this potential expense by adding a long term care rider to your annuity contract.2 Annuities with long term care riders usually have more lenient medical underwriting than traditional long term care insurance policies.2 Note that an annuity isn’t considered long term care insurance. Long term care riders are typically available for an additional cost within an annuity and may not pay the entire cost of long term care.
How to buy an annuity: A step-by-step guide
So now that we’ve reviewed why people choose annuities, let’s walk through the steps of buying one. Since annuities are insurance contracts, they aren’t purchased the same way stocks and mutual funds are. But if you follow the steps we lay out here, you should be able to easily find an annuity that fits your needs.
1. Understand your financial goals
First, talk with a financial professional. They can help you consider your lifestyle, financial situation, risk tolerance, and goals to determine if an annuity is a good fit for you. But if you’re looking for protection from market downturns while saving for retirement, the potential for lifetime guaranteed income, or tax-advantaged growth, chances are an annuity could be a good choice.
2. Research and choose based on your financial objectives and goals
Do your research and enlist the help of your financial professional for this step. In addition to checking out all the types of annuities and rider options — and there are a lot — you’ll want to understand how an annuity would fit into your investment portfolio.
1. Figure out your retirement date. This is good to know because annuities are often used to supplement other retirement income (like Social Security) to cover fixed expenses (like housing) in retirement. So establish when you plan to retire, calculate how much income you’ll need annually at that point, and then use that information to determine the amount of your annuity.
2. Choose how your earnings will be calculated. Annuities tend to come in three varieties:
Fixed annuities. You’re guaranteed a minimum interest rate and a set amount of payouts.5
Variable annuities. You can apply your premiums to specific investment options. Your payout is based on how much money you contributed, how your investments performed, and any fees and other costs. Variable annuities are subject to investment risks, including possible loss of principal.5
Indexed annuities. This is a hybrid option with returns tied to a stock market index, like the S&P 500. Typically, these offer a cap on any potential earnings and a floor for any potential losses.6
There’s also a relatively new annuity option called the registered index-linked annuity (RILA). This contract links returns and losses to a stock market index, but has the added protection of a buffer — in fact, these annuities used to be called “buffer annuities.”7 The buffer provides protection from losses up to a certain threshold that you specify. Registered index-linked annuities are subject to possible loss of principal and earnings.
3. Choose how you’ll be paid. Do you want to receive an income stream for the rest of your life, for a set number of years, or all at once? Work with your financial professional to determine what makes the most sense for you, and then customize your annuity contract accordingly.
4. Choose who is getting paid. Should the annuity be just for you or should it pay out for the life of both you and your spouse? Who will be your beneficiary? Again, your financial professional can help you sort through these factors. Withdrawals of taxable amounts are subject to ordinary income tax and may be subject to a 10% additional federal tax if withdrawn before age 59½.
3. Select your provider
Typically, annuities are purchased through an insurance company. But you can also buy them from brokerage firms, mutual fund companies, and banks.3 Regardless of who you purchase with, a licensed insurance agent will need to be involved in the final submission of your contract to the insurance carrier.
Because annuities are contracts backed by the claims-paying ability of the insurance carrier, you’ll want to do your research and be sure the provider you choose is reputable.8 To evaluate this, look at financial ratings from agencies like Moody’s, AM Best, and Standard & Poor’s (S&P).8
There are other factors to consider when choosing your provider. You’ll want to examine the type of death benefits offered and understand the minimum guaranteed returns you can expect.9 Also, be sure to ask about surrender fees you’ll be charged if you decide to withdraw funds early, as well as the administrative fees assessed over the life of the contract.9
4. Complete and submit an application
Annuity contract applications are similar to those you’ve probably filled out when you opened a bank or brokerage account. You may need to provide information like your Social Security number, date of birth, address, and the names of any beneficiaries.5
Once you receive your quote from the insurance company, complete your application as soon and as carefully as you can to be sure you get the rate quoted to you.8 Any mistakes or inconsistencies in your application can delay your processing time.
5. Fund the annuity
Depending on your contract, you can pay for your annuity with cash, funds from retirement accounts [i.e., rolling over a 401(k) or transferring assets from an IRA], or a transfer from a brokerage account.5 Note that your transfer must abide by the terms of your previous account. Talk with your financial professional to be sure you understand the tax implications of how you’ll fund the annuity. The IRS also allows a tax-free transfer of an existing annuity contract to another annuity contract of the same kind via a Section 1035 Exchange.10
As always, it’s a good idea to be aware of any fees from a transfer from other funds to your annuity contract. Speak with your financial institutions and a financial professional to be sure you understand any costs and penalties that might be associated with your transfer.
Know that you won’t receive any additional tax-deferral benefit from placing IRA or other tax-qualified funds into an annuity. Features other than tax-deferral should be considered in the purchase of a qualified annuity. When rolling over or exchanging funds, please consider all the costs, such as annual maintenance fees, surrender charges, and death benefits.
When should you buy an annuity?
This question is tough to answer since it depends on your individual situation and needs. If you’ve maxed out all you can put into retirement savings accounts — accounts like IRAs and 401(k)s — then it’s probably a good time to purchase an annuity.8 And keep in mind that the sooner you can purchase a deferred annuity, where the payouts come to you at a later date, the more time the principal has to grow.8 It can certainly feel intimidating to sign a large, long-term contract; be sure to speak with a financial professional to have all your questions answered.
Those are the basic steps involved in buying an annuity. Annuities can be an excellent addition to a retirement portfolio and long-term financial planning, especially when you consider the opportunity for protection against market downturns, guaranteed lifetime income, and tax-advantaged growth they can offer.
Things to consider
- Talk with a financial professional to understand how an annuity can complement your retirement plan.
- Consider an annuity if you’re concerned about the effects of market volatility on your investments.
- If you’ve already maxed out your contributions to employer-sponsored retirement plans, look into how an annuity could provide additional tax-deferred growth.
1“’Ugly Times’ Are Pushing Record Annuity Sales. Here’s What You Need to Know Before You Buy.” CNBC.com, October 2022
2“Reasons to Buy an Annuity,” Annuity.org, December 2022
3 “Annuities,” Investor.gov, accessed January 2023
4“Who Needs Care?” LongTermCare.gov, May 2022
5“How to Buy an Annuity,” Forbes.com, October 2022
6“What Is a Variable Annuity?” Forbes.com, August 2022
7“Registered Index-Linked Annuity,” Annuity.org, January 2023
8“Buying an Annuity,” Annuity.org, December 2022
9“Annuity Companies & Providers,” Annuity.org, January 2023
10“What Is a 1035 Exchange? Definition and How the Rules Work” Investopedia.com, December 2022
Transamerica Resources, Inc. is an Aegon company and is affiliated with various companies which include, but are not limited to, insurance companies and broker dealers. Transamerica Resources, Inc. does not offer insurance products or securities. The information provided is for educational purposes only and should not be construed as insurance, securities, ERISA, tax, investment, legal, medical or financial advice or guidance. Please consult your personal independent professionals for answers to your specific questions.