Can You Purchase an Annuity With Cash?

An annuity is a contract between an individual and an insurance company, designed to provide regular income payments, often for retirement. Many individuals wonder if an annuity can be purchased with “cash.” The answer is yes; annuities can be funded with readily available liquid funds. These funds typically originate from sources such as savings accounts, checking accounts, or brokerage accounts, rather than physical currency. The tax implications of an annuity are significantly influenced by whether the funds used for its purchase were pre-tax or after-tax.

Understanding “Cash” as an Annuity Payment

While physical cash is generally not accepted for annuity purchases due to anti-money laundering regulations, “cash” in this context refers to liquid assets. Acceptable forms of payment include funds from bank accounts, money market accounts, or proceeds from the sale of other assets like stocks, bonds, or real estate that have been converted to cash. The emphasis is on the funds being readily available and verifiable.

Common methods for transferring these funds include electronic funds transfers, such as ACH or wire transfers. Wire transfers are typically the fastest, often completing on the same day, though they may incur fees ranging from $15 to $50. ACH transfers usually take between one and three business days to process. Personal checks, certified checks, or cashier’s checks are also accepted, with personal checks typically taking five to ten business days to clear, while certified or cashier’s checks clear more quickly.

Tax Classifications of Annuity Funds

The tax treatment of an annuity is primarily determined by the tax status of the funds used for its purchase. This distinction categorizes funds into either qualified or non-qualified. Understanding these classifications is crucial for anticipating future tax obligations.

Qualified funds originate from pre-tax retirement accounts, such as Traditional IRAs, 401(k)s, 403(b)s, and SEP IRAs. When an annuity is purchased with these funds, often through a direct rollover, all distributions from the annuity, encompassing both the principal and any earnings, are taxable as ordinary income upon withdrawal in retirement. Early withdrawals before age 59½ from qualified annuities may also incur an additional 10% federal tax penalty, unless a specific IRS exception applies, such as disability or substantially equal periodic payments. Guidance on these rules is detailed in IRS Publication 590-A and 590-B.

Non-qualified funds are sourced from after-tax accounts, meaning income taxes have already been paid on the principal contributions. These funds typically come from personal savings, brokerage accounts, or inheritances. For annuities purchased with non-qualified funds, only the earnings portion of distributions is subject to taxation as ordinary income. The return of the original principal is received tax-free.

For partial withdrawals, the IRS generally applies a “last-in, first-out” (LIFO) rule, meaning earnings are considered to be withdrawn first and are therefore fully taxable until all earnings are exhausted. Similar to qualified annuities, earnings withdrawn from non-qualified annuities before age 59½ may also be subject to the 10% early withdrawal penalty.

The Annuity Purchase Process

Purchasing an annuity involves a structured process, beginning with a thorough assessment of an individual’s financial situation. This initial step typically involves working with a financial professional to determine the suitability of an annuity for specific income and retirement goals. The professional helps identify the appropriate type of annuity, such as fixed, variable, or indexed, along with any desired features or riders.

Once a suitable annuity product is identified, the application process commences. This involves completing an application form that details personal information, financial background, and beneficiary designations. Subsequently, the funds are transferred to the insurance company. This funding can be executed via wire transfer, an ACH transfer directly from a bank account, or by mailing a personal, certified, or cashier’s check.

After the application and funds are submitted, the insurance company conducts an underwriting review. This process ensures all information is accurate and complete, leading to the issuance of the annuity policy. Upon receiving the policy, the policyholder enters a “free look” period, which typically ranges from 10 to 30 days, depending on state regulations. During this period, the policyholder can review the contract terms and, if desired, cancel the annuity for a full refund without penalty.

Important Considerations Before Buying

Before committing to an annuity, several factors warrant careful consideration to ensure the product aligns with financial objectives. Annuities are designed as long-term financial instruments, and accessing funds prematurely can result in surrender charges. These charges, typically a percentage of the amount withdrawn, often start higher (e.g., around 7%) in the initial years and gradually decline over a period, commonly five to ten years. Some contracts may allow for penalty-free withdrawals of a small percentage of the contract value, often 10%, each year.

Various fees and charges are associated with annuities. These can include:
Administrative fees.
Mortality and expense fees (particularly for variable annuities, often 0.5% to 1.5% annually).
Costs for optional riders, which offer additional benefits like guaranteed lifetime income or inflation protection, typically add 0.25% to 1.5% annually to the annuity’s cost.
For variable annuities, underlying investment fund expenses also apply.

Inflation can erode the purchasing power of fixed annuity payments. While some annuities offer inflation riders, they often incur additional costs or provide fixed increases, not direct inflation ties. Assess the issuing insurance company’s financial stability by checking ratings from agencies like A.M. Best or S&P. State guaranty associations offer protection, typically covering up to $250,000 in benefits if an insurer becomes insolvent, though limits vary by state. Understand all contract terms before finalizing your purchase.