Annuities are often marketed as the “ultimate safety net”—a way to ensure you never outlive your money. While they can be a valuable tool for retirement income, they carry unique “fine print” risks that can complicate, or even derail, a thoughtful estate plan.
If you are considering an annuity as a vehicle for wealth transf
Annuities can create a “liquidity trap” in your estate plan, often restricting annual withdrawals to 10% or less and leaving heirs with limited access to principal.
er, it’s critical to look past the guaranteed checks and understand how these contracts impact your heirs and your access to capital.
1. The Liquidity Trap: Restricted Withdrawals
The most immediate risk of an annuity in an estate plan is the lack of liquidity. Unlike a standard brokerage account where you can sell assets at any time, annuities are legal contracts with rigid “walls” around your principal.
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The 10% Rule: Most contracts only allow you to withdraw up to 10% of the account value annually without penalty. If your estate needs a sudden infusion of cash—perhaps for medical emergencies or to cover a sudden tax liability—you may find your own money “locked away.”
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Surrender Charges: If you need to withdraw more than the allowed amount, you’ll likely hit a surrender charge. These fees often start at 7% to 10% and can last for a decade. For an estate plan, this means your assets are not “nimble”; they cannot be easily reallocated if your family’s needs or tax laws change.
2. The Tax “Step-Up” Disadvantage
One of the most powerful tools in estate planning is the Step-Up in Basis. When you leave a stock or real estate to an heir, their “cost basis” is adjusted to the value at the time of your death, potentially saving them thousands in capital gains taxes.
Annuities do not receive a step-up in basis. When your beneficiaries inherit an annuity, they are responsible for paying ordinary income tax on all the growth within the contract. Because ordinary income tax rates are typically higher than capital gains rates, your heirs could lose a significantly larger chunk of their inheritance to the IRS than if you had left them a standard investment portfolio.
3. The “Death Benefit” vs. Principal Risk
Many people assume that if they die shortly after starting an annuity, the remaining balance automatically goes to their kids. This is not always the case.
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Straight Life Payouts: If you select a “Life Only” payout option, the insurance company keeps the remaining balance when you pass away. Your heirs get nothing.
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The Cost of Protection: To ensure your heirs receive a payout, you must often purchase a Death Benefit Rider. These riders come with annual fees that eat into your returns, effectively charging you a premium to leave your own money to your family.
4. Complexity and “Zombie” Assets
As we move into 2026, the estate tax landscape is shifting. With federal exemptions remaining high (roughly $15 million per individual for 2026), many people are finding that the tax-deferral benefits of annuities are less valuable than the flexibility of other assets.
An annuity can become a “zombie asset”—it sits in your estate, growing tax-deferred, but it’s too expensive to move, too restricted to spend, and carries a heavy tax bill for whoever gets it next.
Is an Annuity Right for Your Legacy?
Annuities aren’t “bad,” but they are inflexible. They are designed for income, not necessarily for inheritance. If your primary goal is to leave a liquid, tax-efficient legacy for the next generation, you might find better success with tools like Irrevocable Life Insurance Trusts (ILITs) or stepped-up brokerage accounts.
We Can Help ~ Michigan Estate Planning in 2026
The estate planning attorneys of the Penzien Legal Group, PLLC have been helping families and business owners with their estate planning needs for more than two decades. If you are looking for a compassionate professional that can help you through the estate planning process, conduct a review of your existing estate plan, or if you would like additional information about our services, give us a call at (586) 464-1900, complete our contact us form or book an appointment using our convenient calendar link. Set up a strategy session today.