Annuity Purchase Pitfalls


Do Not Rush Into a Decision

Be careful, be deliberate, go slow and don’t be afraid to shop around for information.

An annuity purchase is one of the most important financial decisions one would make given the long-term and potentially irrevocable nature of the decision.

You want to avoid—at all costs—getting stuck in something that is not right for you because it can be difficult and expensive to reverse that decision.


High Fees and Expenses

Not all annuities are created equal from an expense standpoint.  For example, a pure life annuity is going to be much less expensive than a variable annuity with living benefits.  To a certain extent, you get what you pay for—the variable annuity has more working parts that are expenses to create and maintain.

Just be sure that you understand and need all the bells and whistles, otherwise the expense is impossible to justify.

Remember that annuities are insurance or risk management products, and look for risk management to become a much more prominent aspect of the retirement planning process in the next several years.

All of the above said, you need to be effectively using the risk management features of the more expensive and complicated annuities, otherwise the expense is wasted.  


The Hard Sell

The sales process needs to be objective and educational.  Walk away from a situation if you get the sense that sales pressures are overriding all aspects of the process.

You must avoid being sold an annuity that fits someone else’s agenda but is not suitable for you.



There is unfortunately no avoiding the fact that annuities are unfortunately complex financial products.  The complexity is even an issue for advisors and other industry professionals.

The complexity is a negative because it increases the likelihood of a poor recommendation and purchase decision.


Lack of Good Information

Partly as a result of product complexity, there is a general lack of independent, high quality annuity information sources.  This is particularly the case with consumer information.

As a result, it is challenging to conduct the type of independent research that is a core part of the purchase of so many consumer products and services.  It also contributes to consumer dependence on financial advisor information.  This is why it can be useful to shop around to compare input from various industry sources.


Loss of Control

Buying an annuity means that control over your assets passes to an insurance company.

Handing over all or even a portion of one’s hard-earned life savings to an insurance company is gut wrenching for anyone.

While annuities often make perfect sense rationally, the practical reality is that there are enormous psychological barriers involved in any annuity purchase.

Much of this natural resistance boils down to the fact that most people prefer to maintain control over their life savings, even if it “makes sense” not to do so.


Liquidity Constraints

In the past, annuity product were relatively inflexible and basic—you would hand over a sum of money to an insurance company and hope to live long enough for the decision to make financial sense.  In the interim, most or all of that money would be tied-up and inaccessible to the annuity owner.  In other words, the funds would be illiquid because they could not be easily converted to cash to cover current expenses.

Annuity product features have evolved rapidly over the past decade, however, and there currently are many products and product options that address liquidity concerns.  For example:

  • Some annuities allow for free withdrawals.
  • Some annuities have loan provisions.
  • Some annuities provide for a waiver of surrender charges in certain situations such as the confinement of the annuity owner to a long-term care facility.
  • Some annuities contain provisions that allow for full surrenders.


Bequest Constraints

For many people, part of the retirement planning process involves determining how to pass along some money to heirs as an inheritance.  In other words, many people have a bequest motive.

In most cases—but not all—there is a fundamental trade-off between guaranteed retirement income through an annuity and the ability to provide heirs with an inheritance because money used to purchase an annuity typically decreases the amount of an inheritance.

A core part of the financial planning process and annuity purchase decision involves balancing the need for secure retirement income with the desire to provide an inheritance.

Credit Risk

At the moment, there is no avoiding the fact that an annuity is only as good as the insurance company’s ability to honor a very long-term financial commitment.

While state guarantee funds provide some backstop for consumers in the event of insurance company insolvency, there are financial limits to the levels of support in any given state.

Avoid being tempted by a product offer that seems too good to be true.  The aggressive, sizzling product offer of the week is very likely unsustainable.

The stability and reputation of the insurance company may actually take precedence over the product features and pricing.



Misrepresentation refers to an inaccurate description of the nature or suitability of an annuity product by a financial advisor.

While misrepresentation is an issue in many financial product sales, sales pressures, product complexity and poor information are contributing factors in the annuity industry.


Lack of Suitability

Suitability refers to whether an annuity recommendation or sale is appropriate given a customer’s unique profile and needs.

Industry regulators have gone to great lengths to implement processes at the point of sale that are intended to ensure that the annuity is appropriate for the customer.

That said, there remain situations in which the type of annuity sold is completely inappropriate for the customer.


Age and Annuities

Age is a key factor in annuity suitability or lack thereof.

For example, it is inappropriate and harmful for elderly person in relatively poor health to have their funds tied-up in an annuity with high surrender charges.

Unfortunately, the elderly are often prime targets for unscrupulous sales tactics.

Regulators have become increasingly focused on protecting the elderly, but there is a real risk that remains.


Misleading Software and Calculators

As discussed in the chapter on financial planning, there is no perfect financial planning software or calculator.  Do not blindly rely on the results of any software.  This applies to self-service calculators on the Web and to more sophisticated software that may be used by your financial advisor.  You should challenge the assumptions that are used and understand that any results should simply serve as reference points for a larger conversation.