What Is an Annuity?
An annuityAnnuityAn insurance product that earns interest and generates periodic payments over a specified period of timetypically with the purpose of providing income in retirement. is a contract with an insurance company that converts your savings into steadypredictable income. Many retirees turn to annuities to protect their life in retirementguard against market swings to help ensure they do not outlive their savingsand create peace of mind for themselves and their families.
Why Annuities Matter
Lifetime income. One of the greatest fears people have going into retirement is running out of money. Annuities directly address this concern by offering payments that can last as long as you live. With a lifetime income annuityyou can create a financial safety net for essentials such as housinggroceriesand healthcare.
Protection from market losses. Unlike investments that fluctuate with the stock marketcertain annuities offer a reliable income stream even when markets decline. This insulation from volatility can help preserve your retirement lifeparticularly if you don’t want to risk losing savings at a stage of life when recovery time is limited.
Tax-deferred growth. While you wait to begin taking incomemany annuities allow your money to grow on a tax-deferred basis. This means you won’t pay taxes until you start receiving paymentsallowing your savings to compound more efficiently over time.
Options for your family. Retirement planning isn’t just about you — it’s also about those you love. Many annuities include death benefits or beneficiary provisions that ensure a spousechildrenor other heirs receive income from the remaining value of the contract after your passing. This legacy feature can be especially meaningful for people who want their savings to provide support beyond their own lifetime.
Types of Annuities
Different types of annuities are designed for various needsand the “right” option for you often depends on your risk toleranceretirement timeline and the type of life you want to support. These are some of the types of annuities available for your retirement.
Fixed
Annuities
provide reliable growth by offering a guaranteed rate of return for a set period.
Indexed Annuities
tie growth to a market indexgiving you the chance for higher returns while protecting against losses.
Variable Annuities
invest in underlying fundsoffering flexible growth potential along with greater risk.
Choosing can feel overwhelmingbut seeing how real people in similar situations use annuities can make the decision more straightforward.
When Different Types of Annuities Make Sense
Each story highlights the emotional triggerthe practical fitand the peace of mind payoffso you can quickly see which option may align with your retirement strategy.
Linda68 – Retired teacher
Fear: “I’m terrified one market crash will wipe out my retirement savings.“
Linda feels relieved knowing she won’t lose money in a downturn. She can finally give herself permission to enjoy retirement.
Marcus60 – Small business owner
Fear: “If the market drops just before I retireI won’t have time to recover.“
Marcus can participate in market gains but still sleep at nightknowing he won’t wake up to devastating losses just before his retirement begins.
Emily55 – Corporate executive
Fear: “I hate the thought of not protecting my savings from the market’s volatility.“
Emily likes knowing she can still aim for higher returnsbut she has a safety net to ensure her retirement life won’t collapse if markets underperform.
Annuities can be a great tool to help you generate retirement income or reach other financial goalsbut there are many kinds of annuities. It’s important that you understand how they work to know if one is right for you.
Brandon RenfroPh.D.CFP®RICP®EACo-Owner of Belonging Wealth ManagementAs a Certified Financial Planner™ professional and Retired Income Certified Professional®Brandon Renfro is well-versed in the financial information and strategies needed to meet retirement goals. In addition to co-owning Belonging Wealth Management and assisting clientsBrandon writes regularly for financial publications.
Quick Annuity Comparison
See how each annuity type compares at a glance — from risk and growth potential to when payments begin.
| Type | Best For | Risk Level | Growth Potential | When Payments Start |
|---|---|---|---|---|
| Fixed | Conservative savers | Low | Steadyguaranteed | Future |
| Indexed | Growth and protection | Low-Medium | Moderate | Future |
| Variable | Higher risk investors | Medium-High | High | Future |
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How Annuities Work
At their coreannuities take the money you contributeknown as a premiumand turn it into a reliable stream of income. This process happens in two main phases: the accumulation phase and the payout phase. Understanding how each phase works can help you see why annuities are often used as a foundation for retirement security.
Step 1: Paying the Premium
When you buy an annuityyou start by paying a premium to the insurance company. This can be done as a single lump-sum paymentsuch as rolling over a portion of your 401(k) balanceor as a series of payments made over time.
Step 2: Accumulation Phase
Once your money is invested in the annuityit enters the accumulation phasewhere it grows on a tax-deferred basis. That means you won’t pay taxes on the growth until you start taking money outgiving your savings more room to compound compared to taxable products such as CDs or brokerage accounts.
Step 3: Choosing How To Get Paid
When you’re ready to turn your savings into incomeyou can annuitize the contract by converting it into guaranteed paymentsor you can make systematic withdrawals. Payments can begin right away with an immediate annuity or at a future date using a deferred annuity.
You also choose the structure of your payoutwith three different options:
- Monthly income for life
- Payments for a set number of years
- Income that covers you and a spouse
Your choice will affect both the size of your payments and the level of protection for your family.
Step 4: Income Starts
Once the payout phase beginsthe insurer assumes the most significant risks you face in retirementmarket risk and longevity risk (the possibility of outliving your money). In exchangeyou agree to the terms of the contractwhich may include fees or place limits on liquidity.
Why This Matters
- Tax-deferred growth gives your money a chance to compound fasterwhich can make a noticeable difference over long time horizons.
- Risk transfer means you don’t have to shoulder the burden of unpredictable markets or worry about running out of income if you live longer than expected.
How Do Annuities Pay Out?
With annuitiesyou choose how income is paid outwhether it is for a set periodyour entire lifetime or the lifetimes of you and your spouse.
| Option | What You Get | Best For | Trade-Off |
|---|---|---|---|
| Period Certain | Payments for 5-20 years | Covering near-term expenses | Payments stop after the term |
| Single Life | Lifetime income | Maximizing monthly income | No survivor benefits |
| Life w/Period Certain | Lifetime income with minimum years guaranteed | Balancing lifetime income & legacy | Lower payment than straight life |
| Joint & Survivor | Income while either spouse is alive | Spousal protection | Lower payment than single life |
How Annuity Rates Impact Payout
Annuity rates play a direct role in how much income you receive.
- Higher rates = bigger monthly checks. When prevailing interest rates are higherinsurance companies can invest your premium more profitablywhich allows them to pay you more income.
- Lower rates = smaller payouts. In low-rate environments, your monthly income will be lower because the insurer earns less from its investments.
Timing also matters. Locking in an annuity when rates are rising often results in better payouts than buying when rates are near historic lows.
Other factors applytoo. Your agesexpremium amountand payout type all interact with rates. For exampleeven with a modest ratestarting at an older age generally produces higher monthly payments because the insurer expects to pay for fewer years.
In shortannuity rates dictate the size of your guaranteed income. The higher the rate at the time you purchasethe more you’ll receive each month for the same premium.
Earn up to $6K Annual Interest on a $100K Annuity
Annuities vs. Other Products
When deciding where to keep your moneyit helps to compare annuities to other common savings tools. The chart below highlights the key differences in interest ratestermstaxesand withdrawal rules when comparing fixed annuitiessavings accountsand certificates of deposit (CDs).
Disadvantages of Annuities
No financial product is perfectand annuities are no exception. While they can provide lifetime income and peace of mindthey also come with trade-offs that may not fit every retiree’s needs. Before you commitit’s essential to understand the potential downsides.
1. Limited Liquidity
Once you invest money in an annuityit can be hard to access without penalties. Most contracts restrict how much you can withdraw each yearand early withdrawals often trigger surrender charges.
If you withdrawal more than the allowed amountespecially within the first 5 to 10 yearsyou may face significant fees that reduce your payout.
2. Fees and Costs
Variable and indexed annuities often carry several feesincluding administrative feesmortality and expense chargesand optional rider costs. These fees can eat into your returns if not carefully considered.
3. Complexity
Annuities can be hard to understand. The variety of productsridersand payout options means it takes time to make a fully informed choice. Professional guidance can be extremely helpfulenabling you to make a more informed decision.
4. Potentially Lower Returns
Compared with investing directly in stocks or mutual fundsannuities may deliver lower long-term growth. The trade-off is security and guaranteed income versus higher growth potential with more risk.
5. Tax Treatment on Withdrawals
While growth is tax-deferredwithdrawals are taxed as ordinary incomewhich means they do not share the lower rates of capital gains. That can result in a bigger tax bill for some investors.
6. Inflation Risk
Unless you add an inflation rider (often at extra cost)fixed payments can lose purchasing power over time as the cost of living rises.
Is an Annuity Right for You?
Annuities aren’t right for everyonebut for many retirees they can provide peace of mind and protection with guaranteed income. Our Annuity.org calculator can help you determine if an annuity can strengthen your retirement plan.
We asked Senior Annuity Specialist Scott Saffe to answer common questions about how annuities work and what to consider before choosing one.
Q&A With Scott SaffeSenior Annuity Specialist at Annuity.org
With over 28 years of experience in the annuity industryScott brings a well-rounded perspective to Annuity.org. He understands our customers in a way that enables deep and meaningful connections to develop over time.
- How do I decide between a lump-sum payout and lifetime income?
It depends on your goals. A lump sum provides immediate access to your entire balancewhich can be useful for paying off debt or covering large expenses. Howeverit puts the responsibility on you to manage the money so it lasts. A lifetime income optionon the other handguarantees steady payments for liferemoving the risk of outliving your savings. Many retirees choose lifetime income for peace of mind and use other assets for liquidity.
- What happens to my annuity if the insurance company has financial trouble?
Annuities are backed by the issuing insurerso choosing a financially strong company is critical. Independent ratings agencies like AM Best and Standard & Poor’s evaluate insurers’ financial strength. In additionevery U.S. state has a guaranty association that provides a safety net (up to certain limits) if an insurer fails. Working with a licensed specialist ensures you understand both the company’s strength and the protections in your state.
- Can I lose money with an annuity?
With a fixed annuityyour principal is protectedso you won’t lose money due to market declines. Indexed annuities protect against losses but cap your growth potential. Variable annuities carry investment risk — your returns depend on the performance of subaccountsand you could lose value. It’s important to match the annuity type to your risk tolerance and financial needs.
- How do fees affect my annuity payout?
Fees can significantly impact returnsespecially with variable and indexed annuities. Common charges include administrative feesmortality and expense (M&E) feesand rider costs for benefits like guaranteed withdrawals or long-term care coverage. While these features can be valuablethey reduce your net growth. Always compare fee structures and ask your agent to show you the impact of fees on projected payouts.
Is An Annuity Right For You?
