What Is the Biggest Disadvantage of an Annuity?
TL;DR: The single biggest disadvantage of an annuity is liquidity restriction. You commit your money for a defined period (5-15 years for most products), and pulling more than the 10% free withdrawal triggers surrender charges. Fees come second (variable annuities especially), and complexity comes third (FIA income riders especially). But each disadvantage is conditional. It depends on the product type and the buyer's situation. Below: the honest ranking, and when each one actually matters.
CD vs MYGA, after tax
What $100,000 earns in 5 years: CD vs MYGA, after tax
Rates used: CD 4.50%, the top nationally available 5-year CD (DepositAccounts, September 24, 2026); change it to the rate you are offered. MYGA 5.95%, the best A-rated rate we track as of October 13, 2026: Delaware Life Pinnacle Plus 5-year (AM Best A-, negative outlook, 7/31/2026), $100,000 and up, effective October 6, 2026 (Delaware Life rate sheet).
| CD, interest taxed every year | $118,826 |
|---|---|
| MYGA, tax-deferred, before tax | $133,507 |
| MYGA after paying tax on all the interest at withdrawal | $126,136 |
| Tax deferral alone adds about | $674 |
| MYGA ahead of the CD, after tax | $7,310 |
Assumes 22% federal and 0% state income tax, no withdrawals, rates held for the whole term. MYGA interest is taxed as ordinary income when you withdraw it, not as capital gains. Gains taken before age 59 1/2 can owe a 10% IRS penalty, and cashing out early can cost a surrender charge. In an IRA both grow tax-deferred, so the edge there is the rate alone. Bank and credit union deposits are FDIC or NCUA insured up to the limits; a MYGA is backed by the issuing insurer's claims-paying ability and your state's guaranty association up to its limits, not the FDIC. General education, not tax, legal or financial advice.
The honest ranking
- Liquidity restriction: affects every type of annuity (MYGA, FIA, SPIA, VA)
- Fees: massive for variable annuities, modest for FIAs with riders, zero for MYGAs and SPIAs
- Complexity: high for FIA income riders, moderate for FIA crediting strategies, low for MYGAs and SPIAs
- Opportunity cost: the rate you locked at year 1 may underperform what's available 3 years later
- Surrender charges: rare to actually trigger if you understand the contract, but painful when they hit
- Tax inflexibility: once annuitized, payments are locked; once distributed, can't be undone
- Inflation risk: level-payout SPIAs lose real purchasing power over 20+ years
- Carrier risk: rare but real; mitigated by AM Best rating, state guaranty fund
1. Liquidity restriction (the biggest one)
Every deferred annuity has a surrender period, typically 5 to 15 years. During that period, you can take out the "free withdrawal" amount (usually 10% per year), but anything above that is subject to surrender charges that start around 8-10% in year 1 and decline to zero by the end of the surrender period.
Why this matters: if you have $300K in a MYGA and a medical emergency requires $100K, you can take $30K free, but the other $70K is subject to surrender charges. On a year-3 surrender at a 7% charge, that's $4,900 of penalty.
When it doesn't matter: when you've sized the annuity correctly (i.e., it's a portion of your assets, not all of them). The standard rule: never put more than 30-50% of liquid net worth into annuities. Keep enough outside annuities to handle any reasonable emergency.
SPIAs are different: once you annuitize a SPIA, there's no liquidity at all. You exchanged the lump sum for an income stream. This is by design.
Is the annuity you're looking at actually the best one available?
Send your email and I'll send what it really guarantees, what the surrender schedule costs you, and the two or three carriers paying more for the same guarantee. If it's already a good fit, I'll tell you that.
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2. Fees
The fee picture varies dramatically by product type:
| Product | Typical annual fees | What you're paying for |
|---|---|---|
| MYGA | 0% | Nothing; rate is net |
| SPIA | 0% | Nothing; payout is net |
| FIA (no rider) | 0% | Nothing; cap/par is net |
| FIA + income rider | 0.95-1.50% | Lifetime income guarantee on benefit base |
| Variable annuity (no rider) | 1.00-1.75% (M&E) | Wrapper, mortality, expense risk |
| Variable annuity + GLWB + sub-accounts | 2.50-3.50% | Wrapper + rider + fund expenses |
If you bought a VA with riders, fees are your number one issue. A 3% drag over 20 years vaporizes roughly half the balance versus a 0% drag instrument. If you bought a MYGA, fees are not an issue. The rate quoted is the rate paid.
3. Complexity
The most-misunderstood annuity feature is the FIA income rider's "benefit base" vs "cash value." The benefit base is the number used to calculate the lifetime income, and it often grows at a rate higher than the cash value (e.g., 7% benefit base roll-up). Many buyers think the benefit base is their cash. It's not. It's an accounting figure used only to compute the income payment.
If you surrender the FIA, you get the cash value, not the benefit base. The two diverge over time, sometimes by 30-50%.
SPIAs and MYGAs don't have this issue. SPIA = monthly payment, fixed. MYGA = rate, fixed. Simple.
4. Opportunity cost (rate environment)
Say you lock a 5 year MYGA at 5.50%. In 18 months, rates spike to 6.50%. Your money is locked at the lower rate. The 10% per year free withdrawal partially mitigates this, but you're still mostly stuck.
This is real but overstated. Rate environment risk runs both ways. Rates could drop to 4% next year too. Locking your rate at a competitive level protects against the downside. The opportunity cost only feels bad when rates go up.
Mitigant: ladder rather than lump-sum. A ladder of 3, 5, 7, and 10 year MYGAs means a portion matures each year and can be redeployed at then-current rates.
5. Surrender charges
Surrender charges are the cost of breaking the contract early. They're a feature, not a bug. The carrier built the rate guarantee assuming you'd stay through maturity. Pulling out early costs the carrier money; the surrender charge offsets that.
Typical schedule: 9% year 1, 8% year 2, 7% year 3, descending to 0% at year 7 (for a 7 year MYGA) or year 10 (for a 10 year FIA).
Surrender charges only matter if you actually surrender. With proper sizing (don't over-allocate to annuities), you shouldn't need to surrender.
6. Tax inflexibility
Once you take a non-qualified annuity distribution, the LIFO rule applies: earnings come out first (fully taxable), basis comes out last (tax-free). You can't selectively pull basis. Inside an IRA, all withdrawals are ordinary income regardless.
Once you annuitize a SPIA, you can't undo. The election is permanent.
7. Inflation risk (level payout SPIAs)
A SPIA paying $2,000/month today buys ~$1,500/month of purchasing power in 15 years at 2% inflation, or ~$1,000 at 4%. Level-payout SPIAs lose ground over long horizons.
Mitigants: buy an inflation-rider SPIA (starts ~35% lower but escalates), use the SPIA only for essentials (which often inflate less than discretionary), keep growth assets outside the SPIA bucket.
8. Carrier risk
Annuity carriers can fail. Executive Life of NY (1991), Mutual Benefit (1991), Penn Treaty (2017). State guaranty funds covered most losses but with delays and caps.
Mitigants: A or A+ AM Best rating, split large positions across carriers to stay under state guaranty caps, prefer mutual companies over highly-leveraged stock companies for long contracts.
When each disadvantage actually bites
| Disadvantage | Bites for | Doesn't matter for |
|---|---|---|
| Liquidity restriction | Anyone over-allocating to annuities | Properly sized annuity (< 40% of assets) |
| Fees | Variable annuity buyers with riders | MYGA / SPIA / no-rider FIA buyers |
| Complexity | FIA income rider buyers who don't read the contract | MYGA / SPIA buyers |
| Opportunity cost | Lump-sum buyers in rising-rate environments | Laddered buyers |
| Surrender charges | Buyers who didn't plan for liquidity needs | Buyers who hold to maturity |
| Tax inflexibility | Non-qualified annuity buyers wanting basis-first withdrawals | IRA annuity holders |
| Inflation risk | Level-payout SPIA buyers with 25+ year horizons | Inflation-rider or short-horizon buyers |
| Carrier risk | Buyers using B or B+ carriers, concentrating > guaranty cap | A/A+ buyers respecting state caps |
So what's the actual biggest disadvantage?
For most buyers, it's liquidity restriction. The 10% per year free withdrawal is real but limited. If you're not planning your liquidity buckets carefully (HYSA for 1 year, T-bills/MYGA for 3-5 years, growth/index for 10+ years), you'll find the annuity restricting you at exactly the moment you need flexibility.
For VA buyers, it's fees. 2-3% per year is a multi-decade drag that exceeds whatever benefit the riders provide for most buyers.
For FIA rider buyers, it's complexity. Not because the product is bad, but because the benefit base vs cash value distinction is easy to misunderstand.
Related reading
- What happens to an annuity when the spouse dies?
- Non-qualified annuity tax explained
- How much does a $100K annuity pay per month?
- How much does a $1 million annuity pay per month?
- Annuity vs stable value fund
Frequently Asked Questions
Are annuities really worth the lockup?
For the right buyer at the right size, yes. The certainty of guaranteed lifetime income (SPIA) or guaranteed rate (MYGA) has value when paired with the rest of a retirement plan. The trade-off only works if you sized correctly.
What's the worst-rated annuity product on the market right now?
Variable annuities with stacked riders and high sub-account expenses. Fees can exceed 3.5% per year. Most buyers don't get what they paid for.
Can I cancel an annuity in the first 30 days?
Yes. Every state has a 'free look' period of 10-30 days during which you can return the contract for a full refund. Use it if you have second thoughts.
Do annuities have hidden fees?
MYGAs and SPIAs do not. FIAs without riders do not. VA and FIA with income rider have rider fees that are disclosed but easy to overlook. Always ask for a written illustration showing all fees.
Is it bad to have all my money in an annuity?
Yes. Standard practice: cap annuity allocation at 30-50% of liquid net worth. The rest stays in liquid, growth, and tax-flexible vehicles.
Can a SPIA disadvantage be reversed if I die early?
Only with a 'cash refund' or 'period certain' SPIA. Pure life-only SPIA pays nothing after death. Choose the rider that matches your priorities.
What's the disadvantage of an annuity versus a CD?
CDs have FDIC up to $250K and no surrender charges (just interest forfeiture for early withdrawal). Annuities offer higher rates, tax deferral (non-qualified), and lifetime income option. Different tools for different jobs.
Should I avoid annuities because of all these disadvantages?
Only if you can't size and structure them properly. Used correctly, the right annuity solves problems no other product solves (guaranteed lifetime income). Avoid based on bad fit, not on category prejudice.
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Disclosure
This article reflects publicly available product materials and approximate rates as of the date stated above. Annuity rates, caps, participation rates, payout factors, crediting methods, and tax rules change frequently. Confirm current figures in the latest carrier disclosure and the contract before you buy. This article is general information for educational purposes; it is not a personalized recommendation, solicitation, or offer of any specific product, nor is it tax or legal advice. Hans Goldstein is an independent licensed insurance producer (NPN 20602398) appointed with multiple A-rated carriers across the annuity and long-term care insurance market; specific appointment status with any carrier discussed may vary, and discussion of a carrier is not an endorsement or representation of carrier appointment. No compensation has been received from any carrier in connection with the publication of this article. Always read the actual contract and consult a licensed advisor and a CPA or tax attorney before purchasing any annuity or making rollover decisions. Annuities are long-term contracts with surrender charges; they are not suitable for funds you may need before the end of the surrender period. AM Best ratings, payout factors, and tax treatment are subject to change. References to the TSP, FERS, CSRS, OPM, USPS, Social Security, IRMAA, WEP/GPO, IRC §72, §453, and §1035 reflect rules as of 2026 and are subject to change.