5 Annuity Rules to Know Before Buying One This August

As the summer of 2025 approaches, many Americans are turning their attention to retirement planning. With economic uncertainty, rising inflation, and a volatile stock market, securing a reliable income stream has become a top priority for retirees and those on the brink of retirement. Annuities, which promise guaranteed income for life, can be a valuable tool—but only if you understand the rules before making a purchase.

1. The 1% Fee Rule: Keep Total Costs Below This Threshold

When shopping for an annuity, one of the most critical factors to consider is the total annual cost. Any annuity with total fees exceeding 1% should raise red flags unless it offers exceptional guarantees or features not found elsewhere. This includes management fees, mortality and expense charges, administrative costs, and rider fees combined.

Simple immediate annuities often have no ongoing fees, while low-cost deferred annuities typically keep total costs well under 1%. These can be excellent options for investors. However, variable and indexed annuities often come with higher fees—sometimes reaching 3% or more annually. At those levels, the insurance company takes a significant cut, which could hinder your long-term growth.

2. The 10-Year Rule: Don’t Buy a Deferred Annuity Unless You Can Wait a Decade

Deferred annuities are designed for long-term growth, but they may not be the best choice for everyone. Historical data suggests that deferred annuities may not outperform low-cost index funds over periods shorter than 10 years. If you withdraw funds before the 10-year mark, you may also face surrender charges.

If you're within 10 years of needing income, immediate annuities might be a better fit. These start paying out right away and avoid the growth period entirely, offering more immediate financial security.

3. The Income Floor Rule: Cover Essentials First

Before considering an annuity purchase, it's essential to calculate your essential monthly expenses. This includes housing, utilities, food, healthcare, insurance, and minimum debt payments. The income floor rule suggests that these non-negotiable costs should be fully covered by guaranteed income sources such as Social Security, pensions, or annuities.

Once you've secured this income floor, you can invest remaining assets in growth-oriented investments like stocks or bonds. This strategy ensures you avoid both over-purchasing and under-purchasing, helping you maintain a balanced and sustainable retirement plan.

4. The 25% Allocation Rule: Don’t Overcommit to Annuities

Financial planners generally recommend limiting your total annuity allocation to no more than 25% of your retirement portfolio. This rule helps prevent over-concentration in illiquid products while allowing annuities to serve their role as portfolio stabilizers.

For example, if you have $1 million in retirement assets, your annuity investment should not exceed $250,000. This maintains diversification and ensures flexibility in adapting your strategy as circumstances change over time.

5. The 4% Rule: Use It as an Annuity Benchmark

The 4% rule for annuities is a way to evaluate whether an annuity's guaranteed income stream is equal to or better than what you might safely withdraw from a traditional portfolio. For instance, if you have $500,000 in retirement savings, the traditional 4% rule suggests you could safely withdraw $20,000 in the first year.

If an immediate annuity offers $25,000 annually for life, that 5% payout rate appears more attractive. However, annuity payments usually don’t adjust for inflation unless you opt for that feature, while the 4% rule assumes annual inflation adjustments. Use 4% as a baseline, but factor in longevity protection, inflation adjustments, and liquidity trade-offs when making your decision.

The Bottom Line

Annuities can be valuable tools for retirement planning, but they require careful consideration of your specific circumstances and goals. While the annuity market may seem complex, you don’t want to oversimplify your decision either. Take time to understand any annuity you're considering, compare it to alternatives, and ensure it aligns with your timeline and liquidity needs.

The right annuity purchased at the right time can provide decades of financial security. The wrong one, however, can lock up your money in an underperforming investment that you’ll ultimately regret.