Behind the Annuity Conundrum: The Belief They’re Unfair

For me, it’s just arithmetic. If I can “buy” an inflation-adjusted life annuity from the US Gov’t for about 50% less than what an insurance company would charge for that same monthly check by waiting until age 70 to collect Social Security, why would I ever agree to buy one from an insurance company?



I have nothing to say about the governments way of doing things, except to note that one way they clearly differ from insurance companies is that insurance companies have to make a profit.

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Absolutely! It’s a free country. If you see value in subsidizing excessive Executive Compensation in the financial services industry by purchasing an annuity from a for-profit insurer, have at it.



This was posted in 2018. Has something changed that made it more relevant today?

Nope. In fact, you are seeing it today because of a continuous learning process that has NOT changed. You see, there MIGHT be somebody new who hasn’t thought about it - yet.

I guess? But this is a paper published by the industry decrying the idea that the public views annuities as “unfair.” Not really the sort of article one might turn to learn about the potential downsides of an annuity.

This paper advocates people consider annuities, not the stay away from them.

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Mea Culpa, I was referring to Intercst bringing this up again, and not anything to do with the actual content of the article, which I also disagree with then, now and in the future.

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The article was about how those open to considering an annuity perceived them to be fair and those opposed to an annuities consider them to be unfair.

We know that @Intersect is opposed to annuities and I assume that you are as well. The article didn’t address why an annuity might be a good or bad idea.

The question in my mind is how much of the monthly annuity payment is a non-taxable return of capital and how much is taxable income? In addition, how much would I have to pay in federal and state income taxes to acquire an annuity?

Reporting requirements mandate that .gov and you be provided this information via year end reporting. The IRS will be in sync with you when you receive your 1099-R.

Look. There’s nothing wrong with an annuity. You can construct your own, if you’d like.

The products offered by the industry certainly guarantee a payout LOWER than you can safely obtain yourself. If you construct your own, you have the added benefit of not incurring a taxable event unless you so choose.

Take a $5MM nest egg and annuitize 40% of it. That $2MM goes into an account with the same entry criteria as an annuity. Deferred, immediate or some blended scheme.

The balance of the portfolio is free floating in whatever (hopefully) more aggressive scheme you’d like.

For the $2MM, invest in bonds and pay exactly .1% less than the bonds promise. No fees, perpetual income and bedrock certainty provided by the US government (or whatever basket of blue chip bonds you so choose.)

-the best part-

You pay yourself the 1% “fee” for managing it. Understanding Annuity Fees: The Truth You Need to Know (2023) (

Also payable to you, the 7% early Can You Cash Out an Annuity? Process, Pros & Conswithdrawal penalty for not laddering the bonds and receiving the principle back, if you like.


If you buy an annuity inside your IRA, at least initially, you wouldn’t be paying any income taxes. But 100% of the annuity benefit would be taxed as income when you withdraw it, just like anything else in an IRA.

The big disadvantage of an annuity is revealed when you compare it to the monthly benefit increase you get by delaying SS to age 70. The quote you get from a commercial insurer for that same monthly benefit will cost much more. Again, it’s just arithmetic. There may be nonfinancial reasons to buy an annuity. Maybe your wife wants one, and your life would be a lot easier if she’s not complaining about it.


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The term “Annuity” is unfortunately a “catch-all” for many different things. There are roughly a dozen different types of annuities and just about as many ways to take income from them.

A non-qualified (non-IRA) annuity is funded with after tax dollars. You can take money out of it in various ways - it does not always (or even usually) require annuitization. The majority of deferred annuities are never annuitized - they are simply used as tax deferred CDs and they are either cashed in at maturity or rolled into a new annuity, just like a CD.

If you do annuitize it, then the non-taxable portion is calculated using what is called the exclusion ratio (based on an assumed life expectancy and the IR of the annuity).

Annuity Exclusion Ratio: What It Is and How It Works.

That being said, many annuities come with riders that provide guaranteed income for life (for a fee) without the need to annuitize. How they calculate the taxable portion can be varied and product specific.

Note, you don’t pay any taxes to acquire an annuity but any of the income earned would be subject to normal income taxes like the income from a bond, CD, or savings account. In general, if one is going to consider an annuity, I think you are better off using retirement (IRA) dollars since it will already be taxed as income vs using money that could otherwise generate dividends and/or capital gains.