Annuities can provide guaranteed income for life, but they’re complex and come with costs. Here’s a quick overview of what you need to know:

• What is an annuity? A contract with an insurance company that turns your savings into regular payments, either for life or a set time.
• Why consider an annuity? They offer steady income, protection from market volatility, and tax-deferred growth.
• Types of annuities: Fixed, variable, and indexed annuities vary in risk, returns, and costs. Immediate annuities start payouts right away, while deferred annuities grow over time before paying out.
• Costs to watch: Fees like administrative charges, surrender penalties, and commissions can reduce returns.
• Tax rules: Qualified annuities are taxed on withdrawal, while non-qualified ones tax only the earnings.
• Drawbacks: Limited liquidity, high fees, and potential inflation impact on fixed payments.

Feature	Fixed Annuity	Variable Annuity	Indexed Annuity
Risk	Low	High	Moderate
Earnings Potential	Limited	Unlimited	Capped
Principal Protection	Yes	No	Yes
Costs	Minimal	Higher	Moderate

Annuities work best as part of a broader retirement plan. Pair them with Social Security and other savings to ensure financial stability. Always consult a financial advisor to understand fees, taxes, and whether an annuity fits your goals.

Who Should Buy an Annuity & Who Should NOT Buy an Annuity?

What Are Annuities and How Do They Work?

An annuity is a financial tool designed to provide a steady stream of income, either for a set period or for the rest of your life. Essentially, it’s an agreement between you and an insurance company: you pay them a lump sum or a series of payments, and in return, they promise to pay you regular income in the future. This income comes from your original investment plus any interest earned, as the insurance company invests your money over time. The reliability of these payments depends on the financial stability of the insurer.

Unlike bank deposits, annuities are not insured by federal agencies like the FDIC or SIPC. Instead, states provide certain protections if the insurance company fails, but these vary depending on where you live. This makes it crucial to choose a financially strong insurer since their ability to meet their obligations is key to the annuity’s guarantees.

The popularity of annuities has grown significantly. In the second quarter of 2022, total U.S. annuity sales hit $77.5 billion, the highest ever recorded by LIMRA. This trend continued, with sales exceeding $105 billion in the first quarter of 2025, reflecting a 3% increase from late 2024. These numbers highlight the increasing role annuities play in financial planning.

An annuity contract typically includes several key parties: the insurer, the owner (who funds the annuity), the annuitant (whose life determines the payment schedule), and a beneficiary. The contract outlines important details like payment terms, penalties for early withdrawals, and provisions for spouses or other beneficiaries.

Main Features and Benefits of Annuities

One of the biggest benefits of annuities is the assurance of a steady income during retirement, helping to guard against the risk of outliving your savings. Once you enter into a contract, the insurance company guarantees regular payments – whether monthly, quarterly, or annually – providing a sense of financial security.

Annuities also offer protection from market volatility. Unlike other investments that may fluctuate with market conditions, annuities can provide stability, making them attractive for those seeking predictable income.

Flexibility is another advantage. You can choose from immediate annuities, which start payments right away, or deferred annuities that begin payments at a future date. Some contracts even allow partial access to your principal, giving you more control over your payouts.

Tax benefits are another draw. The money in your annuity grows tax-deferred, which means you don’t pay taxes on the earnings until you start receiving payments. This can be especially useful if you expect to be in a lower tax bracket during retirement, potentially reducing your overall tax burden.

Drawbacks and Things to Consider

While annuities come with benefits, there are also drawbacks to keep in mind. One of the main concerns is their cost. Variable annuities, in particular, often come with higher fees compared to fixed annuities. These fees can include investment management charges, surrender fees, mortality and expense fees, and administrative costs, all of which can eat into your returns.

Liquidity is another issue. Annuities are not easily accessible, and withdrawing money early can result in hefty penalties. While some contracts allow small annual withdrawals without penalty, taking out larger amounts can be expensive.

The complexity of annuity contracts can also be a challenge. These agreements are often lengthy and filled with technical jargon about surrender periods, withdrawal rules, and payout calculations. Some even include teaser rates that drop after an initial period, making it essential to read the fine print carefully.

Inflation is another factor to consider. Fixed annuity payments remain consistent, but their purchasing power can decrease over time as the cost of living rises. Additionally, the funds you invest in an annuity might earn higher returns in other investments, though those alternatives typically come with more risk.

Before committing to an annuity, it’s wise to do your homework. Consulting a financial advisor can help you better understand the terms, fees, and tax implications, ensuring you make an informed decision.

Types of Annuities: Choosing What Works for You

Understanding how annuities work is just the beginning. To create a retirement income plan that suits you, it’s important to explore the different types of annuities available. Each type is designed to meet varying financial goals and comfort levels with risk.

Interestingly, annuity sales have been on the rise, as more retirees look for dependable income options.

Fixed, Variable, and Indexed Annuities

Annuities generally fall into three main categories, each offering different levels of risk and growth potential.

Fixed annuities provide a guaranteed interest rate, offering steady growth without the stress of market fluctuations. They’re a solid choice if you prioritize stability and want to protect your principal.

"Fixed annuities are the safest type of annuity contract in the market. They offer guaranteed, fixed rates of interest and appeal to highly risk-averse investors that are uncomfortable with volatility."

• Thomas Brock, CPA and expert contributor for Annuity.org

Variable annuities, on the other hand, invest your money in sub-accounts tied to the market. While this opens the door to higher potential returns, it also comes with increased risk – your principal isn’t protected from losses.

Indexed annuities strike a balance between the two. They tie your earnings to a market index, such as the S&P 500, allowing you to benefit from market growth while safeguarding your initial investment. However, these gains are often capped, so you won’t fully capitalize on strong market performance.

Feature	Fixed Annuity	Indexed Annuity	Variable Annuity
Interest Rate	Fixed	Linked to market index	Varies with investments
Risk	Low	Moderate	High
Earnings Potential	Limited	Higher (with caps)	Unlimited
Costs	Minimal	Possibly higher fees	Higher fees
Principal Protection	Yes	Yes	No

Choosing the right type depends largely on your comfort with risk and your financial goals. Fixed annuities work well for those seeking steady, predictable income. If you’re open to market fluctuations for the chance at higher returns, variable annuities might be a better fit. Indexed annuities offer a middle ground, giving you some market exposure while protecting your principal.

"If you are risk-averse and desire predictable income, a fixed annuity may be better. If you’re looking for a higher return potential and can take market volatility, a variable annuity might be suitable."

• Sherman Standberry, CPA and managing partner at My CPA Coach

Next, let’s look at how the timing of payments – immediate or deferred – affects your retirement income strategy.

Immediate vs. Deferred Annuities

Beyond the investment features, the timing of payments is another critical factor when choosing an annuity. This decision determines how and when you’ll start receiving income.

Immediate annuities begin payments within 12 months of purchase. You make a single lump-sum payment, and the insurance company starts sending you regular income almost immediately. This option is ideal if you’re already retired or need income in the near term.

"An immediate annuity, which can be thought of as an instant annuity, is an insurance product that can help provide a steady, predictable income stream in retirement. In exchange for one lump-sum payment, you get ongoing income. It’s called an immediate annuity because the income payments start right away."

• New York Life

Deferred annuities, by contrast, delay payments, allowing your investment to grow during an accumulation period. These can be funded through a lump sum or periodic payments, and you can choose to start receiving income years – or even decades – later.

"A deferred annuity is an insurance contract that helps provide retirement income over a specified period of time in exchange for a lump-sum or ongoing premium payments. Depending on how far away from retirement you are, you can defer your income stream until later to give your investment time to grow during an accumulation period."

• Thrivent

Feature	Deferred Annuities	Immediate Annuities
Funding	Lump sum or periodic premiums	Lump-sum premium only
Payout Start	At least 12 months after purchase	Within 12 months of purchase
Earning Potential	Allows for growth during accumulation	Limited growth potential
Taxation	Growth is tax-deferred; taxed at payout	Payments are taxable
Death Benefit	May include remaining balance for beneficiaries	May include remaining balance for beneficiaries

The choice here boils down to your time horizon. If you need income right away, an immediate annuity can provide that stability. If you can wait, a deferred annuity offers the potential for greater growth and flexibility. Evaluate your other income sources – like Social Security, pensions, and investments – to decide whether immediate income or delayed payments better align with your retirement goals.

Annuity Costs and Fees Explained

Understanding the costs associated with annuities is essential for making informed retirement decisions. While annuities can provide benefits like guaranteed income and tax-deferred growth, they also come with fees that can eat into your returns. Here’s a breakdown of the common fees and their impact.

Common Fees and Charges

Annuity fees can vary widely depending on the type of contract you choose. For example:

• Administrative fees: These range from 0.10% to 0.50% of your contract value annually and cover account maintenance and transaction processing costs.
• Surrender charges: These fees, which apply if you withdraw funds early, can range from 1% to 10%. For instance, an eight-year annuity might start with an 8% surrender charge in the first year, decreasing by 1% each year until the term ends. Most surrender charge periods last between six and ten years.
• Commissions: Built into your purchase price, commissions typically range from 5% to 7% of your initial investment for fixed and variable annuities. Fixed index annuities often carry higher commissions, around 6% to 8% for a 10-year contract, while single premium immediate annuities usually have lower commissions, at 1% to 3% .

"It’s worth asking any time you’re working with someone – whether it’s a firm like Schwab who offers access to annuities, or an individual annuity company or a person – ask ‘how are you being paid? Are you being paid a commission?’"

• Rob Williams

Variable annuities come with additional costs, including:

• Mortality and expense (M&E) risk fees: These typically range from 1% to 1.5% of your account balance annually.
• Investment management fees: Sub-account fees generally range from 0.5% to 2% of your account balance annually.
• Rider fees: Optional benefits like guaranteed income or death benefits come with fees between 0.25% and 1% of your contract value annually.

Fee Type	Variable Annuity	Fixed Index Annuity	Fixed Annuity	Immediate Annuity
Commissions	✓	✓	✓	✓
Administrative Fees	✓	✓	✓	✓
Surrender Charges	✓	✓	✓
Mortality Expenses	✓	✓
Investment Expense Ratio	✓	✓
Riders	✓	✓	✓	✓
Rate Spreads		✓

To make the most of your investment, compare fees across different products to find low-cost options. Limit additional riders to only those that are necessary for your financial goals. A financial advisor can help you navigate these choices and minimize costs.

Withdrawal Rules and Penalties

Early withdrawals from annuities can come with additional costs, including fees from the insurer and penalties from the IRS.

• Surrender charges: These fees apply during the accumulation phase for early withdrawals, typically ranging from 1% to 10% depending on the term. However, many annuities allow penalty-free withdrawals of up to 10% of your contract value annually .
• IRS penalties: Withdrawals made before age 59½ incur a 10% penalty in addition to regular income taxes. The IRS considers earnings as withdrawn first, meaning taxes apply to the entire withdrawal amount until gains are fully depleted. Additionally, all withdrawals are taxed as ordinary income, which could push you into a higher tax bracket if you withdraw large sums.

To avoid these penalties, it’s best to wait until after age 59½ to withdraw funds. Planning withdrawals after the surrender charge period ends can also save on fees. If your contract allows, take advantage of penalty-free withdrawals up to 10% of your account value annually.

Smart withdrawal strategies can help reduce penalties and taxes. For example:

• Spread withdrawals over multiple years to stay in a lower tax bracket.
• Time withdrawals around crediting periods to minimize penalties.
• Set up a systematic withdrawal schedule instead of taking large lump sums.

The IRS does offer exceptions to the 10% penalty for cases like disability, death, or long-term care expenses . However, these exceptions won’t eliminate surrender charges from the insurance company.

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How Annuities Are Taxed

Annuities offer tax-deferred growth, meaning you won’t owe taxes until you start withdrawing funds. This feature can help you manage your tax obligations more effectively. However, how taxes apply depends on how the annuity was funded and when you begin taking withdrawals.

Tax Rules for Qualified vs. Non-Qualified Annuities

The way your annuity is taxed hinges on whether it’s classified as qualified or non-qualified.

• Qualified annuities are funded with pre-tax dollars, often through retirement accounts like 401(k)s or traditional IRAs. Since contributions were not taxed initially, any withdrawals are fully taxable as ordinary income.
• Non-qualified annuities are purchased with after-tax dollars from personal savings. In this case, only the earnings portion of each withdrawal is taxable, while the principal is returned tax-free because taxes were already paid on those contributions. The IRS uses an exclusion ratio to determine the taxable portion of each payment.

Annuity Type	Funding Source	Tax Treatment	Required Minimum Distributions
Qualified	Pre-tax dollars (e.g., 401(k), IRA)	Entire withdrawal taxed as ordinary income	Yes, starting at age 73
Non-Qualified	After-tax dollars (personal savings)	Only earnings are taxable; principal is tax-free	No RMDs during the owner’s lifetime

Qualified annuities are subject to Required Minimum Distributions (RMDs) starting at age 73, similar to other pre-tax retirement accounts. On the other hand, non-qualified annuities do not require RMDs during the owner’s lifetime.

Next, let’s explore how your payout choices can affect your tax situation.

How Payout Choices Affect Your Taxes

The way you choose to receive your annuity payments plays a big role in determining your tax liability, particularly in terms of timing and the total taxes owed.

• Lump-sum withdrawals can result in a hefty tax bill. For qualified annuities, the entire withdrawal is taxed as ordinary income in the year you take it. If it’s a large amount, it could push you into a higher tax bracket. With non-qualified annuities, a lump-sum withdrawal means paying taxes on all the earnings at once.
• Regular payments, on the other hand, spread out the tax burden over several years. In non-qualified annuities, the exclusion ratio ensures that each payment includes both taxable earnings and a tax-free portion of your principal. This approach can help you stay in a lower tax bracket.

Timing your withdrawals strategically can also help reduce your overall tax burden. For instance, delaying withdrawals until you’re in a lower tax bracket can save you money. Additionally, state tax laws vary, so where you live may also impact your total tax liability.

Here are a few tax-saving tips to consider:

• Delay withdrawals if you anticipate being in a lower tax bracket later.
• Manage distributions from non-qualified annuities to avoid overlapping taxable income.
• Annuitize payments to benefit from consistent tax treatment via the exclusion ratio.

It’s always a good idea to consult a tax advisor to ensure you’re following the rules, avoiding penalties, and minimizing your tax burden effectively.

Adding Annuities to Your Retirement Plan

Annuities are most effective when they work alongside other elements of a retirement plan, such as Social Security, 401(k)s, and other savings. Instead of relying on them as a standalone solution, they should complement your broader strategy to ensure steady income throughout retirement. Here’s how annuities can fit into your financial picture.

Using Annuities with Other Income Sources

A solid retirement plan often relies on multiple income streams working together. For many retirees, Social Security serves as the foundation. However, in 2014, the average monthly Social Security benefit was $1,317 for men and $1,033 for women at age 65. With median household balances in workplace retirement savings plans at just $111,000 in 2013, many retirees face a gap between their income and expenses. Annuities can help bridge this gap.

Annuities offer guaranteed income and protect against market volatility. They also provide tax-deferred growth, even if you’ve already maxed out contributions to other tax-advantaged accounts. For those without a traditional pension, annuities can replicate the steady, lifelong income pensions provide. Unlike employer-funded pensions, annuities are funded by you and allow for customization, letting you decide when payments start and how much they’ll be.

One strategy is to divide your savings into different "income buckets" across various products. This approach ensures a baseline income from guaranteed sources like Social Security, pensions, and annuities, while leaving room for growth through other investments. Experts recommend covering about two-thirds of retirement expenses with guaranteed income sources.

Here are a few practical ways to integrate annuities with other income sources:

• Delay Social Security: If your annuity income covers early retirement expenses, you can delay Social Security until age 70 to maximize benefits.
• Use an annuity ladder: Purchase smaller annuities at different times or with staggered start dates. This strategy can add flexibility and help counteract inflation.
• Manage income thresholds: Keep annuity withdrawals at levels that avoid triggering higher taxes on your Social Security benefits.

To determine how annuities fit into your plan, consider your overall financial picture. Timing your annuity income can help address longevity concerns and preserve your assets.

When Annuities Make Sense

Annuities can provide distinct advantages, but their value depends on factors like your retirement age, overall assets, and income needs. For many, the strongest reason to consider an annuity is longevity protection. If you’re concerned about outliving your savings, annuities can guarantee income for life, offering peace of mind – especially as life expectancies rise and traditional pensions become less common.

For example, a 67-year-old retiree with $1 million could see a 32% increase in income by annuitizing one-third of their savings compared to following a 4% withdrawal strategy. This demonstrates how annuities can help stretch retirement savings further.

Annuities also play a role in asset preservation. Research shows that pensioners’ non-housing assets declined by just 4% over 18 years, compared to a 34% drop for non-pensioners. By reducing the need to withdraw heavily from other investments, annuities can help protect your assets.

"Collecting both Social Security and annuity income is not just possible; it’s also a smart way to create a more stable and predictable financial future in retirement." – Angelica Leicht, Senior Editor, CBSNews.com

"We analyze their retirement plan, their savings and their life goals to provide a clear idea of how much income will need to be replaced." – TIAA Wealth Management Advisor Melissa Shaw

The key to incorporating annuities is balance. Factors like your age, risk tolerance, retirement goals, and financial situation will determine how much of your savings to allocate to annuities.

Key Points for Retirees to Remember

Before deciding on an annuity, take a close look at your retirement goals, liquidity requirements, and comfort level with risk. If you prefer stability and predictable income, annuities may be a good fit. On the other hand, if you’re open to some risk for the chance of higher returns, variable annuities might appeal to you. For a detailed breakdown of costs and taxes, revisit the earlier sections covering these topics.

As previously mentioned, fees can take a significant bite out of your returns. Be sure to review the "Annuity Costs and Fees Explained" section for specifics on administrative expenses, surrender charges, and rider fees that could impact your overall earnings.

Taxes are another critical consideration. How your annuity is taxed depends on whether it’s qualified or non-qualified, as well as the payout options you choose. To minimize tax burdens, coordinate withdrawals with your broader income strategy.

These points emphasize the importance of understanding the strategies discussed earlier. Since annuities can be complicated, working with a professional is highly recommended. In fact, only 19% of Americans can accurately define what an annuity is. Among annuity owners, 84% sought guidance from financial professionals to learn more, and 68% purchased their annuities through advisors.

"Most people approach annuities backward. They focus solely on the product rather than how it fits into their overall plan. That’s like choosing kitchen appliances before designing the house." – Marcel Miu, CFA, CFP, founder of Simplify Wealth Planning

Take your time before committing to an annuity. Ask plenty of questions about features, restrictions, and long-term commitments. Keep in mind how inflation could erode the purchasing power of fixed payments over time, as traditional annuities may not keep pace with rising costs. Ultimately, annuities are most effective when integrated into a broader retirement plan. Consider your full financial picture, including Social Security benefits and retirement savings, to ensure the annuity complements your overall strategy.

FAQs

How do I know if an annuity is the right choice for my retirement plan?

Deciding whether an annuity fits into your retirement plan comes down to your financial goals, the need for reliable income, and your broader strategy. Start by assessing your current and future expenses, your life expectancy, and how much flexibility you’ll need with your funds. If you’re seeking steady, guaranteed income to cover essential costs or to reduce exposure to market risks, an annuity might be worth considering.

Key factors to think about include the timing of payouts, the type of annuity that aligns with your needs – whether that’s immediate, deferred, fixed, or variable – and the financial strength of the insurance company offering it. Annuities can be a solid choice for those who value predictable income and want peace of mind knowing they won’t outlive their savings. That said, it’s critical to account for costs, fees, and any restrictions on accessing your money to ensure it matches your long-term plans.

What should I think about when deciding between fixed, variable, and indexed annuities?

When weighing the options of fixed, variable, and indexed annuities, it’s essential to align your choice with your financial goals, tolerance for risk, and desire for steady income.

• Fixed annuities guarantee consistent payments, making them a solid choice for retirees who value stability and want to avoid taking on risk.
• Variable annuities offer the chance for higher returns since they’re tied to market performance. However, they also come with increased risk, making them a better fit for those comfortable navigating market ups and downs.
• Indexed annuities blend features of both, linking growth to a market index while providing protection from major losses. This option appeals to those looking for a middle ground between safety and growth.

By evaluating your financial needs and how much risk you’re willing to take, you can select the annuity that best aligns with your retirement income goals.

How do annuity fees and costs affect my retirement income?

The costs associated with annuities can significantly affect your retirement income. Typical charges include administrative fees, often about 0.3% of your account value each year, and commissions, which are usually embedded in your contract and can vary greatly. These fees can chip away at your investment growth and reduce the income you’ll receive over time.

To safeguard your retirement savings, take the time to carefully review and understand the fee structure of any annuity you’re considering. Generally, lower fees mean more of your money remains invested, giving it the chance to grow and support your long-term income goals.