Top Five Mistakes People Make When Purchasing an Annuity Contract

Purchasing an annuity can be one of the smartest financial decisions you make for retirement—provided you avoid the traps that catch far too many buyers. Annuities are powerful tools for generating guaranteed income, but they are also complex contracts filled with fine print, fees, and long-term commitments that can be costly to unwind.

After years of guiding Massachusetts families and business owners through retirement protection planning, I've seen the same costly mistakes repeat themselves. Here are the five biggest errors people make when purchasing an annuity—and how to sidestep them.

1. Chasing the Highest Rate Without Reading the Fine Print

It's tempting to shop for annuities the way you'd shop for a savings account: find the highest interest rate and sign on the dotted line. But annuity contracts are far more complex than a simple APY comparison.

The "headline rate" often refers to the base interest crediting rate or the income payout rate, but it doesn't tell the whole story. You need to understand:

• Surrender charges: How long are you locked in, and what does it cost to get out early? Some contracts carry surrender periods of 10+ years with penalties as high as 10% in year one.
• Participation rates and caps: If you're buying a fixed indexed annuity, the "rate" may be capped. A 5% cap with 100% participation isn't the same as a 3% guaranteed rate.
• Rate guarantee periods: That attractive rate may only be guaranteed for one year. After that, the insurance company can reset it—sometimes dramatically lower.

The Fix: Work with an advisor who will explain the entire contract, not just the marketing highlights. The lowest rate with full transparency and flexibility often beats the flashy teaser rate with hidden restrictions.

2. Ignoring Liquidity Needs and Surrender Periods

Annuities are long-term contracts. When you purchase one, you are essentially trading liquidity for guarantees. The problem arises when buyers underestimate how much access they may need to their principal.

Common scenarios that lead to regret:

• A sudden medical expense that requires withdrawing more than the annual free withdrawal amount (typically 10% of the contract value).
• A change in living situation—downsizing, relocating to a different state, or moving into assisted living—that demands a lump sum of cash.
• A change in investment philosophy or family needs that makes the original annuity structure no longer appropriate.

Once you're past the free withdrawal limit, surrender charges kick in, and they can be steep. In some cases, you may also lose bonus credits or enhanced death benefits that were contingent on holding the contract for a minimum period.

The Fix: Before purchasing any annuity, stress-test your liquidity needs. Ask yourself: "If I needed $50,000 unexpectedly next year, what would this cost me?" If the answer makes you uncomfortable, either choose a shorter surrender period (even if the rate is slightly lower) or allocate a smaller portion of your assets to the annuity.

3. Buying the Wrong Type of Annuity for Your Goal

Not all annuities serve the same purpose, yet many buyers treat them as interchangeable. The four main types—fixed, fixed indexed, variable, and immediate—solve very different problems.

• Fixed annuities work well for conservative growth and principal protection.
• Fixed indexed annuities offer growth potential tied to a market index with downside protection.
• Variable annuities allow investment in subaccounts (similar to mutual funds) but come with higher fees and market risk.
• Immediate annuities convert a lump sum into guaranteed income payments starting right away—ideal for someone already in retirement who needs income now.

I've seen retirees buy a variable annuity when they really needed income certainty. I've seen pre-retirees buy an immediate annuity when they actually needed tax-deferred growth for another 15 years. Mismatching the product to the goal is one of the most expensive mistakes you can make.

The Fix: Start with the goal, not the product. Are you looking for guaranteed income, tax-deferred growth, legacy planning, or principal protection? Once your objective is crystal clear, the right annuity type becomes obvious.

4. Underestimating Fees and Their Long-Term Impact

Annuities have a reputation for being fee-heavy, and while not all annuities are expensive, the ones that are can quietly erode your returns year after year.

Fee structures vary dramatically by product type:

• Variable annuities typically charge insurance fees, mortality and expense risk charges, administrative fees, and investment management fees. Total annual costs can range from 2% to 3.5% or more.
• Fixed and fixed indexed annuities often have lower explicit fees, but riders for guaranteed income, enhanced death benefits, or long-term care may add 0.5% to 1.5% annually.
• Surrender charges aren't technically "fees," but they function as a cost if you need to exit early.

Over a 20-year retirement, a 2% annual fee difference can reduce your ending balance by tens of thousands of dollars—or more.

The Fix: Demand a fee disclosure in writing before signing anything. Ask your advisor to illustrate the impact of all fees on your projected returns over 10, 15, and 20 years. If you can't get a straight answer, that's a red flag.

5. Naming the Wrong Beneficiary—or Forgetting to Name One Entirely

Beneficiary designations on annuity contracts are powerful but often overlooked. Unlike assets that pass through a will, annuities transfer directly to named beneficiaries, bypassing probate. This is a benefit, but only if the designations are correct and up to date.

Common errors include:

• Naming minor children directly: Insurance companies generally cannot pay benefits directly to minors. Without a trust or guardianship arrangement, the funds may be tied up in court until the child reaches the age of majority.
• Failing to update beneficiaries after divorce or remarriage: An ex-spouse listed as a primary beneficiary will legally inherit the annuity, regardless of what your will says.
• Naming your estate instead of an individual: This causes the annuity to go through probate, defeating one of the key advantages of the product.
• Not naming a contingent beneficiary: If your primary beneficiary predeceases you and no contingent is named, the contract may default to your estate.

The Fix: Review beneficiary designations at least annually and after any major life event—marriage, divorce, birth of a child, or death of a beneficiary. Consider naming a trust if you have complex family dynamics or want to control how and when beneficiaries receive distributions.

Final Thoughts

Annuities are not inherently good or bad—they are tools. Like any tool, their value depends entirely on whether they match the job at hand and whether the person using them understands how they work.

The best annuity purchase is an informed one. That means asking hard questions, reading the fine print, and working with a fiduciary advisor who is compensated to advise you—not just to sell you a product.

If you're considering an annuity as part of your retirement plan, the most important step isn't choosing a company or a rate. It's getting clear on what you need the annuity to do for you. Once you have that clarity, the right choice becomes far easier to make.

Disclosure: Guarantees in annuities are backed by the financial strength and claims-paying ability of the issuing insurance company. Annuities are long-term investment vehicles designed for retirement purposes. Withdrawals prior to age 59½ may be subject to a 10% IRS penalty tax. This article is for educational purposes only and does not constitute financial, legal, or tax advice.