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As more Americans approach retirement, annuities are often pitched as a way to create a steady, predictable income during retirement. While that promise can be appealing, especially in uncertain markets, financial experts say it’s critical to understand exactly what you’re buying before committing a large portion of your savings.

An annuity is a contract with an insurance company. In exchange for a lump sum or series of payments, the insurer promises to provide income either immediately or at some point in the future. But not all annuities are created equal, and the details can significantly affect your financial security.

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Fees can quietly erode your returns

One of the most overlooked aspects of annuities is their cost structure. Some annuities, particularly variable annuities, come with multiple layers of fees — administrative costs, investment management fees, and optional riders for added benefits. These can add 2% to 4% annually, or more.

In addition, many annuities include surrender charges, which are penalties for withdrawing your money early, often lasting five to 10 years. For retirees who may need flexibility for healthcare or emergencies, these restrictions can be a serious drawback.

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Match the product to your needs

Annuities are often marketed as one-size-fits-all solutions, but they serve very different purposes depending on the type:

• Fixed annuities offer predictable, guaranteed payments but typically lower returns.
• Variable annuities allow investment in market-based portfolios, with higher potential returns — and higher risk.
• Indexed annuities tie returns to a market index, offering some upside with limits and complexity.

Choosing the wrong type could leave you with either too little growth or more risk than you intended. Experts recommend clearly defining your goals: Are you looking for guaranteed income, growth, or a mix of both?

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Liquidity matters more than you think

Unlike a traditional savings account or even many investment portfolios, annuities can limit access to your money. While some contracts allow limited withdrawals, taking out larger amounts early can trigger penalties.

For older adults, this raises an important question: Will you have enough accessible funds for unexpected expenses? Financial planners often suggest keeping a portion of retirement savings in more liquid accounts.

A fixed monthly payment may sound reassuring, but over time, inflation can significantly erode its value. Some annuities offer inflation protection, but these features usually come at an additional cost.

Without such protection, a payment that covers your expenses today may fall short a decade from now.

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The fine print on guarantees

Annuities are often described as “guaranteed income for life,” but those guarantees are only as strong as the insurance company issuing the contract. 

Unlike bank accounts, annuities are not federally insured by the FDIC. Instead, they rely on the financial strength of the insurer, with some backing from state guaranty associations.

Checking the insurer’s credit rating and understanding state coverage limits can provide added peace of mind.

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Take your time and ask questions

Financial advisors caution against rushing into an annuity purchase, especially if the product is complex or the salesperson is emphasizing urgency. Older adults should feel comfortable asking detailed questions, comparing multiple options, and, if possible, consulting an independent financial professional who is not earning a commission on the sale.

Annuities can play a valuable role in retirement planning — but only when they are well understood and aligned with your broader financial picture.