Mistakes people make when they turn an annuity into income

Annuitization is the moment an annuity stops being a pile of money and becomes a stream of payments. For most people it is also the moment the decision stops being reversible. That is why the common regrets are rarely about the idea of guaranteed income. They are about details chosen quickly, or not chosen at all, on a form that cannot be redone.

This post lists the mistakes that show up most often when people turn a deferred annuity into income or buy an income annuity outright, explains how each one happens, what it can cost and how to avoid it. The dollar figures are hypothetical illustrations, not quotes. The background on how the product works is in the guide to single premium immediate annuities, and the definition of the act itself is in the glossary entry on annuitization.

Mistake 1: Treating the decision as reversible

How it happens. The contract has a deferred phase in which you can withdraw money, switch investments or surrender. People assume annuitizing is more of the same. It is not. Once payments start, you generally cannot take back the lump sum, change the payout option or switch insurers. The only exit is a short free-look window, commonly at least 10 days and longer in some states or for replacements.

What it costs. If you need a large sum later, for a medical bill, a home repair, a family emergency, the money is not there. The monthly check keeps coming, but a $60,000 need cannot be met from a $1,500 check without borrowing or selling something else.

How to avoid it.

• Annuitize only the amount that covers expenses you must pay every month, and keep a separate reserve for emergencies and for large, irregular costs.
• Ask the insurer in writing what is reversible. Some contracts allow a commutation or a one-time withdrawal in narrow circumstances; most do not.
• Use the free-look period to read the full contract, not just the summary. If you have doubts, return it.
• Consider annuitizing part of the contract rather than all of it. The post on partial annuitization: turning only part of a contract into income looks at that route.

Mistake 2: Skipping the survivor option, or choosing it without checking the numbers

How it happens. The highest monthly payment is on the quote sheet in bold, and a life-only annuity produces it. A single person, or a couple in a hurry, picks it. Alternatively, a couple picks a joint option because it sounds responsible, without asking what the survivor would receive or what the protection costs.

What it costs. Under a life-only annuity, the payments stop at the annuitant's death. If a spouse depends on the income, the household can lose a large part of its monthly income at the moment it has also lost Social Security or a pension. On the other side, a 100% survivor option can cost a double-digit percentage of the starting check, and if the spouse dies first, that protection is never used.

An example. Say a hypothetical couple is offered $1,700 a month on a single life and $1,480 a month with 100% to the survivor. The protection costs $220 a month, or $2,640 a year. If the annuitant dies in year eight and the spouse lives 20 more years, the joint option pays the spouse $1,480 × 12 × 20 = $355,200 that the single-life option would not. If the spouse dies first, the couple has given up $2,640 a year with nothing in return. The numbers in the post on single life or joint-and-survivor: choosing how an income annuity pays go through the outcomes in detail.

How to avoid it.

• Write down what the survivor's income would be under each option, counting Social Security and any pension.
• Ask for quotes with several survivor percentages and compare the dollar cost of each step.
• For a pension, remember that federal rules often require the spouse's written consent to skip survivor protection; for an individual annuity, the choice is yours and the contract may not ask your spouse at all.

Mistake 3: Annuitizing too much

How it happens. A retiree wants security and a high guaranteed income, and puts most of the savings into the contract. The salesperson shows how much more a bigger premium pays each month.

What it costs. Liquidity. Suppose a retiree has $350,000 and annuitizes $300,000. The remaining $50,000 is the entire reserve for repairs, taxes, health costs and gifts. A $40,000 home repair uses 80% of it. The retiree may then be forced to take a loan, sell a house or live with a leaking roof.

How to avoid it.

• Estimate monthly essentials and subtract guaranteed income from Social Security and pensions. The gap is the amount an annuity needs to cover. Buying more than that gap is a choice about legacy and flexibility, not a need.
• Keep a reserve sized for at least one large irregular expense plus several months of spending.
• Spread the purchase across more than one date or more than one insurer if the size is large. The guide on building an annuity ladder explains one approach.

Mistake 4: Annuitizing at the wrong time, or at the wrong age

How it happens. Retirement arrives, and the deferred annuity's income phase begins because the contract or the salesperson suggested it, or because the buyer assumed income had to start at retirement. Sometimes the start is driven by an artificial deadline, such as a contract's maximum annuitization age.

What it costs. Income annuity payments per dollar generally rise with age, because the insurer expects to pay for fewer years, and they also depend on interest rates at the time. Starting at 65 instead of 70 gives you five more years of checks and a lower check each month. The trade-off is real, but it is not obvious, and it can be made without thinking.

An illustration. Say $200,000 buys $1,150 a month at 65 or, if the buyer waits and the money sits untouched, $1,400 a month at 70. Both figures are invented. The extra $250 a month is $3,000 a year. Waiting five years costs 5 × 12 × $1,150 = $69,000 of checks never collected, and recovering that takes $69,000 ÷ $250 = 276 months, or 23 years, which would be age 93. That simple comparison ignores the interest the $200,000 would earn while waiting, which shortens the break-even, and the spending the buyer would have to do from other sources during those years. The point is that the answer is not obvious, and depends on health, other income and rates, which no sales sheet shows.

How to avoid it.

• Treat the start date as a separate decision from retirement. A buyer can retire at 62 and annuitize at 70.
• Look at what the contract does if you delay: some deferred contracts keep growing the account or a benefit base, and some charge fees meanwhile.
• If your health or family history is a reason to expect a shorter or longer life, bring it into the decision. planning a deferred income annuity start date from 65 to 85 looks at start ages in detail.

Mistake 5: Overlooking the tax treatment

How it happens. The buyer focuses on the monthly figure, not on what is left after tax. The tax treatment of the payments depends on whether the money was after-tax or pre-tax, and the difference is not visible on the quote.

What it costs. For an annuity bought with after-tax money, each payment has a tax-free part and a taxable part, set by the exclusion ratio. For an annuity bought with IRA or 401(k) money, payments are generally fully taxable as ordinary income. Say a hypothetical buyer pays $120,000 of after-tax money for an annuity paying $900 a month, and the insurer calculates an expected return of $180,000. The exclusion ratio is $120,000 ÷ $180,000, or 66.7%. Each $900 payment has $600 tax-free and $300 taxable. The tax-free part adds up to $7,200 a year, so the buyer recovers the full $120,000 after about 16.7 years, and after that every payment is taxable.

If the same $900 came from an IRA annuity, the whole $900 would be taxable from the first payment. That is a difference of $600 a month in taxable income, which can affect the bracket, the taxation of Social Security and Medicare premiums.

How to avoid it.

• Ask the insurer to state the taxable portion before you sign, and ask whether the contract is qualified or non-qualified.
• Have a tax professional estimate the effect on the total return, including Social Security taxation and Medicare premiums.
• If the annuity is in an IRA, check how required minimum distributions interact with the payments; the guide on Should you put an annuity in an IRA? outlines the questions. The overview of taxes is in how annuities are taxed.

Mistake 6: Ignoring inflation

How it happens. A level payment looks generous on day one. Nobody does the arithmetic for year 20.

What it costs. At an assumed 3% inflation, a level $2,000 check buys the equivalent of about $1,107 in current dollars after 20 years, a loss of about 45% of buying power. The details, and options like cost-of-living increases and laddering, are in a flat annuity check and inflation: how purchasing power erodes.

How to avoid it.

• Test the payment at 2%, 3% and 4% inflation over 10 and 20 years.
• Mark which of your other income sources adjust for inflation.
• Get quotes for an increasing version and see where the break-even falls.

Mistake 7: Shopping one quote, and one insurer

How it happens. The annuity comes from the advisor, bank or employer plan that the buyer already knows. The buyer accepts the quote without comparing.

What it costs. Payments for the same age, premium and payout option can differ between insurers, and the difference is permanent. The other cost is concentration. A contract is a promise from one insurer, backed by a state guaranty association only up to a limit. According to NOLHGA (as of June 1, 2025), most states cover $250,000 of annuity present value. A $400,000 purchase from one company exceeds that figure in most states.

How to avoid it.

• Get written quotes from several insurers for exactly the same terms.
• Check each insurer's financial-strength ratings and look up your state's limit with the state guaranty association coverage lookup. The concept is explained in the glossary entry on the guaranty association.
• If the amount is large, consider splitting it between insurers so each contract falls within the guaranty limit.
• Ask whether you are dealing with an agent paid by commission, and how that affects the options shown. The annuity payout calculator gives a rough benchmark for comparing quotes.

Mistake 8: Confusing annuitization with an income rider

How it happens. A salesperson describes "guaranteed lifetime income" and the buyer assumes it works like a plain income annuity. The product is actually a deferred annuity with a rider, which is a different arrangement with a fee, an account value and a benefit base.

What it costs. The buyer expects to be able to do things that the contract does not allow, or does not expect fees that the contract charges. A plain income annuity has no account value, no benefit base and no annual rider fee. A rider keeps an account, charges a fee, and pays a percentage of a base that is not cash. The post on an income rider on a deferred annuity versus a plain income annuity sets them side by side.

How to avoid it. Ask in plain terms: "If I give you this money, can I ever get it back? What do my heirs receive? What exactly do I pay each year?"

Mistake 9: Not naming or updating beneficiaries

How it happens. If the payout includes a period certain or a refund, someone has to receive the remaining money. The form is filled in at purchase and forgotten.

What it costs. A refund can go to a former spouse, to a person who has died, or to the estate and through probate. See annuity beneficiaries and inherited annuity options for how beneficiary designations work.

How to avoid it. Name a primary and a contingent beneficiary, with full legal names, and review the form after any marriage, divorce, birth or death.

A checklist before you sign

1. I have a reserve outside the annuity for emergencies and large irregular costs.
2. I know what the survivor receives under each option and what survivor protection costs in dollars.
3. I have compared written quotes from more than one insurer for the same terms.
4. I know whether payments are taxed under the exclusion ratio or fully taxable, and I have checked the effect on my total tax picture.
5. I have tested the payment against inflation and decided how I will handle it.
6. I know the insurer's financial-strength ratings and my state's guaranty limit.
7. I have named beneficiaries and read the free-look terms.
8. I understand whether this is a plain income annuity or a deferred annuity with a rider.
9. I have had a fee-only planner or tax professional look at the numbers if the amount is large.

Key takeaways

• Annuitization is generally irreversible, so the common regrets come from details chosen quickly: payout option, amount, start date and insurer.
• Keep a reserve outside the annuity, and annuitize the gap between guaranteed income and essential spending, not everything.
• Compare survivor options in dollars, and check what the survivor would still have from Social Security and pensions.
• Tax treatment differs sharply between after-tax and IRA money, so ask for the taxable portion before you sign.
• Compare written quotes from several insurers, test the payment against inflation and keep each contract within your state's guaranty limit.