If you already own an annuity, or are considering one, this article is for you.
Annuities are often marketed as a safe, dependable way to generate retirement income. The promise of guarantees and protection can be appealing, especially for investors who value stability.
But in many cases, the real story is buried deep in the contract.
I regularly review annuities that look fine on the surface, yet quietly drain thousands of dollars per year through fees, restrictions, and unnecessary complexity. Most owners have no idea what they’re actually paying, or what that cost is doing to their long-term results.
What Even is an Annuity?
At its core, an annuity is an insurance contract designed to convert a lump sum into a stream of income, either immediately or at some point in the future. Many retirees use annuities to supplement their income in retirement.
There are several common types:
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Fixed Annuities
Provide a guaranteed interest rate or income stream. Often used by conservative investors who prioritize predictability. -
Variable Annuities
Invest in underlying portfolios (typically mutual funds), with returns and income tied to market performance. -
Indexed Annuities
Link returns to a market index, such as the S&P 500, but usually cap upside and rely on complex crediting formulas.
Each type can serve a purpose in the right situation. The problem isn’t always the concept, it’s the cost structure.
The Annuity Fee Problem Most Owners Don’t Notice
Many traditional annuities contain multiple layers of fees, which can significantly reduce returns over time. These may include:
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Mortality & Expense (M&E) Fees
Built-in insurance charges that often run 1%–1.75% annually. -
Underlying Investment Fees
The internal funds may add another 0.2%–1.5% per year. -
Rider Fees
Optional guarantees (income riders, death benefits, roll-ups) that increase annual costs. -
Surrender Charges
Penalties for exiting the contract early, sometimes lasting up to 12 years.
When you add it all up, it’s not unusual for a variable annuity owner to be paying 2%-3% per year in total costs.
On a $250,000 annuity, that can mean up to $7,500 annually in fees, every year, regardless of performance.
A More Modern Approach: Fee-Based Annuities
The annuity marketplace has evolved significantly in recent years.
Today, there are fee-based annuities designed to be simpler, more transparent, and far more cost-effective. These products eliminate commissions, reduce unnecessary riders, and allow access to low-cost investment options.
For the right client, modern annuities may offer:
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Meaningfully lower ongoing fees
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No surrender charges
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Broad, low-cost investment choices like Vanguard portfolios
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Clear pricing that integrates with an overall financial plan
In many cases, we help clients transition using a 1035 exchange, which allows one annuity to be exchanged for another without triggering taxes.
What Is a Tax-Free 1035 Exchange for Annuities?
A 1035 exchange is an IRS provision that allows you to move money from one annuity to another without triggering taxes. Instead of surrendering the annuity and recognizing gains as taxable income, the funds transfer directly from the old contract to the new one.
This can be especially useful when replacing an older, high-cost annuity with a more modern, lower-fee alternative. As long as the exchange is handled properly and the money never passes through your hands, the transaction remains tax-deferred.
In short, a 1035 exchange lets you upgrade an annuity structure without starting over or creating an unnecessary tax bill.
Signs It’s Time for an Annuity Review
It may be worth exploring alternatives if:
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You purchased the annuity more than five years ago
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You’re paying high fees but aren’t sure what benefits you’re receiving
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The contract feels overly complex or poorly explained
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You want to simplify and consolidate retirement accounts
In many of these situations, a tax-free exchange into a lower-cost, more transparent solution can improve outcomes without starting over.
Common Questions I Hear about Annuities
Can I switch annuities without penalties?
It depends on your surrender schedule. Some contracts are already past that window, or close enough that the cost may be manageable.
Are all annuities expensive?
No. Many newer, fee-based annuities are far more cost-efficient than older, commission-based designs.
Will I lose my income guarantees if I switch?
Not necessarily. Each case is different. The key is understanding what you have and whether those benefits can be replicated or improved.
Final Thoughts
Annuities can play a role in a retirement plan, but only when the costs, structure, and purpose are aligned with your goals.
Unfortunately, many people are sold annuities without ever receiving a clear explanation of how they work, what they cost, or whether better options exist.
If you already own an annuity and want a second opinion, or you’re considering one and want an objective review, we’re happy to help.
Many clients are surprised to learn they can reduce fees, gain flexibility, and improve transparency without triggering taxes. Feel free to schedule a consultation below!
– Clint Kraft
Founder and Financial Advisor, Kraft Capital