Annuities
How an annuity turns a lump sum into income you cannot outlive, what you give up in exchange, and the charges worth understanding before you sign anything.
About this coverage
An annuity is a contract with an insurance company. You hand over money, either all at once or over time, and the company agrees to pay you back on terms set out in the contract — often as income for the rest of your life, however long that turns out to be.
That last part is the whole point. Every other retirement account you own can run out. An annuity is the one product built to pay while you are alive, which is why it gets described as insurance against living a long time rather than as an investment.
What you give up is access and upside. Money placed in an annuity is generally not money you can freely spend, and the guarantees rest on the financial strength of the company that issued the contract rather than on any government insurance.
Annuity Income Estimator
Shows what a lump sum could produce as monthly income using a payout rate you choose and can change. It holds no carrier rates, so it never presents an invented figure as a quote.
Free, and it asks for no contact details.
The main types, and what actually separates them
The word “annuity” covers several quite different contracts. What separates them is where the growth comes from and how much certainty you are buying.
A fixed annuity credits a set interest rate for a set period. A multi-year guaranteed annuity, usually called a MYGA, is the plainest version: a rate locked for a term, much like a bank certificate of deposit, though backed by an insurer rather than by federal deposit insurance.
A fixed indexed annuity credits interest linked to a market index, with a floor that prevents a loss from market movement and a ceiling — a cap, a participation rate, or a spread — that limits the gain. Your money is not invested in the index. The index is only the measuring stick used to decide what interest to credit.
A variable annuity puts your money in investment subaccounts. It can lose value. These are securities and are sold under securities licensing, which is a different arrangement from the products above.
Separately from how they grow, annuities differ in when they pay. An immediate annuity starts income within about a year of purchase. A deferred one grows first and pays later, sometimes many years later.
What decides how much income you get
Four things move the number more than anything else: how much you place, how old you are when income begins, how long you let it grow first, and the payout rate the carrier offers at the time you buy.
Age matters because lifetime income is priced against life expectancy. Starting income at seventy-five buys a higher monthly figure than starting the same amount at sixty-five, because the company expects to make fewer payments.
The shape you choose matters too. Income for one life pays more than income covering two lives, because the second version keeps paying while either person is alive. Adding a guaranteed period, so that payments continue to a beneficiary if you die early, also lowers the monthly figure. None of these is better than another; they are different trades between the size of the payment and who is protected.
Because payout rates change constantly and vary by carrier, state and age, this page quotes none. The estimator lets you put in a rate and see the arithmetic, which is the useful half of the question and the half that does not go stale.
The costs and restrictions to ask about
Surrender charges. Most deferred annuities limit what you can withdraw for a set number of years. Take more than the allowance and a surrender charge applies, usually declining year by year until it disappears. Ask for the full schedule and the annual free-withdrawal allowance in writing.
Rider charges. Optional features, particularly guaranteed lifetime income riders, carry an annual fee taken from the contract. The feature can be worth paying for; what matters is knowing it is not free.
Caps and participation rates can change. On an indexed annuity these are generally not locked for the life of the contract. The contract sets a guaranteed minimum the carrier cannot go below, and that minimum is usually well below the current rate. Ask what it is.
Tax treatment depends on the money used. Growth is tax-deferred, and withdrawals of gain are generally taxed as ordinary income rather than at capital-gains rates. Taking money out before age 59½ can add a federal tax penalty. How an annuity is taxed depends on whether it was bought with retirement-account money, so this is a question for a tax professional about your own situation.
The guarantee is the carrier’s. An annuity is not FDIC insured. It is backed by the issuing company’s ability to pay claims, so the company’s financial strength ratings are worth checking before you sign. State guaranty associations provide limited backup, with limits that vary by state.
Who tends to find one useful
The clearest case is someone approaching or in retirement who has essential monthly costs — housing, food, insurance — that Social Security and any pension do not fully cover, and who would rather close that gap with income that cannot run out than manage withdrawals from a portfolio for thirty years.
It also suits people who know they would sell in a downturn. Protection from your own reaction to a bad market is worth something real, and for some people it is worth more than the upside they give away to get it.
The way to size one is not to ask how much money you have. It is to work out the monthly gap first, and then how much would be needed to cover it. That is what the retirement income gap calculator is for, and it is the sensible order.
Where this does not help
Worth knowing before you spend time on it.
- An annuity is not an emergency fund. Money inside one is restricted for years, so it is the wrong home for savings you may need at short notice.
- It is not the place for money you want fully exposed to market growth. Fixed and indexed contracts trade upside for certainty, by design.
- It does not replace life insurance. An annuity protects you against living a long time; life insurance protects the people who depend on you if you do not.
- A variable annuity can lose value, and is sold under securities licensing rather than as an insurance-only product.
- If your essential costs are already covered by Social Security and a pension, the problem an income annuity solves may not be one you have.
Common questions
- Can I lose money in an annuity?
- It depends on the type. A fixed or fixed indexed annuity is not exposed to market losses, though surrender charges and rider fees can leave you with less than you put in if you exit early. A variable annuity invests in subaccounts and can lose value. In every case the guarantees depend on the issuing insurance company being able to pay claims.
- What happens to the money if I die?
- That is decided by the contract and the payout option chosen. Some options stop at death, which is what makes their monthly payment higher. Others continue to a spouse, or guarantee payments for a set number of years to a beneficiary. It is worth settling this question before you sign, not after.
- How is an annuity different from a 401(k) or IRA?
- A 401(k) or IRA is a tax wrapper around investments you choose; an annuity is a contract with an insurance company. An annuity can be held inside an IRA, which is why the two get confused. The practical difference is that an account can be depleted, while a lifetime income annuity is built to keep paying.
- Are annuity commissions taken out of my money?
- On most fixed and indexed annuities the commission is paid by the carrier and is not deducted from your premium, so the full amount you place goes into the contract. That does not make the product free: the cost shows up in the surrender schedule and in the caps or rates offered. Asking how someone is compensated is a fair question, and a reasonable adviser will answer it.
- Should I put all of my savings into one?
- No. An annuity answers one question — covering income you cannot outlive — and money inside one is restricted for years. Keeping accessible savings outside the contract is the point of only using part of your assets for it.