Annuity

What is an annuity?

An annuity is a contract with an insurance company. You give them money, either all at once or over time, and they promise to pay you income on a schedule, often for the rest of your life. It's a way to create your own personal pension.

It's the reverse of a subscription. Instead of you paying them every month forever, they pay you.

Key takeaways

• You pay an insurance company, and it pays you income later, often for life.
• Three main types: fixed (predictable), variable (tied to investments, usually more fees), and indexed (in between).
• Pros: guaranteed income, protection against outliving your money, tax-deferred growth.
• Cons: fees (especially on variable annuities), money locked up for years by surrender charges, and inflation eating into fixed payments.
• Often a better fit for people near retirement who want guaranteed income than for young investors.

How it works

Pensions used to give workers a monthly check in retirement. Today most people get a 401(k) and are told to figure it out. An annuity lets you turn a chunk of savings into a paycheck that keeps coming after you stop working, so you don't have to worry about running out of money at 85.

The two phases

Accumulation (saving up): You put money into the annuity, as one lump sum or payments over time. While it sits there, it grows tax-deferred. With a variable annuity, you also choose how it's invested.

Payout (getting paid): The insurance company starts paying you, monthly, quarterly, or annually, depending on what you chose.

Immediate vs. deferred

• Immediate annuities start paying you within about a year. They're often used by people who are already retired.
• Deferred annuities start paying later, like at retirement, which gives your money more time to grow first.

The three types

Fixed annuities

These work like a savings product that pays you back on a schedule. You know exactly what you'll get, with no surprises. The downside is that the payment usually doesn't grow, so inflation shrinks what it can buy over time. Best for people who hate risk and want certainty.

Variable annuities

Your payments depend on how the investments you choose perform. If the market goes up, your payments can go up. If it drops, they can drop. Variable annuities also tend to carry the most fees. Best for people comfortable with some risk who want a shot at higher returns.

Indexed annuities

These credit you with part of a market index's gains while limiting your losses. You get some upside with a safety net, but your gains are usually capped. If the market has a great year, you may only get a portion of it. Best for people who want some growth but also want to sleep at night.

Pros

• You don't outlive your money. A lifetime annuity keeps paying as long as you live, even if that's to 100.
• Protection from market crashes. With a fixed annuity, your payment doesn't change when the market drops.
• Tax-deferred growth. You don't pay taxes on growth year by year, only when you take money out.

Cons

• Fees. Variable annuities can stack several charges: mortality and expense charges, administrative fees, fees on the underlying investment funds, and fees for optional riders. Together they can take a meaningful bite out of your returns every year. Ask for the full fee breakdown before you buy.
• Your money is locked up. Most annuities have a surrender period that can last several years. Pull money out during that time and you pay a surrender charge. Don't put money in an annuity if there's any chance you'll need it soon.
• IRS penalty for early withdrawals. Taking money out before age 59½ generally means a 10% tax penalty on the earnings, on top of regular income tax and any surrender charge.
• Inflation. A fixed payment that feels comfortable today will buy less in 20 or 30 years as prices rise.

Who should consider one?

Could be a good fit:

• People who are retired or close to it and want to turn savings into steady income.
• Self-employed people without a pension who want some guaranteed income in retirement.
• People who panic when markets drop and would value a predictable check.

Probably skip it if:

• You're young. With decades until retirement, low-cost index funds in a 401(k) or IRA usually give you more growth and flexibility.
• You might need the money soon. A home down payment, a business, or an emergency fund shouldn't be locked in an annuity.
• You haven't used your tax-advantaged accounts yet. A 401(k) and Roth IRA already give you tax benefits, usually with lower fees.

The real question is this: do you want guaranteed income more than you want maximum growth? If you're close to retirement and the thought of running out keeps you up at night, an annuity may be worth a look. If you have time on your side, you can probably do better elsewhere.

Annuity vs. 401(k) vs. Roth IRA

Feature	Annuity	401(k)	Roth IRA
Guaranteed income	Yes (can be for life)	No	No
Typical fees	Often higher, especially variable	Depends on plan and funds	Depends on funds
Flexibility	Low (surrender period)	Medium	High
Tax treatment	Tax-deferred growth	Tax-deferred (Traditional) or tax-free (Roth)	Tax-free qualified withdrawals
Best for	Near retirement, want guarantees	Still working, employer match	Want flexibility

FAQs

What is the biggest downside of annuities?

Fees (especially on variable annuities), money locked up by surrender charges, and inflation eroding fixed payments. If you're young, you may be paying for guarantees you don't need yet.

Are annuities better than 401(k)s?

Not necessarily. A 401(k) usually offers more flexibility, lower fees, and sometimes an employer match. Annuities provide guaranteed income but lock up your money. Many people use their 401(k) and IRA first before considering an annuity.

Can I lose money in an annuity?

With a fixed annuity, your principal is generally protected. With a variable annuity, you can lose money if the investments perform poorly. You can also lose money to fees and early withdrawal charges. Guarantees depend on the insurance company's ability to pay.

How much does an annuity pay per month?

It depends on how much you put in, your age, current interest rates, the type of annuity, and the options you choose. Payouts change as rates change, so get quotes from several insurers and compare.

What happens to my annuity when I die?

It depends on the options you chose. Some annuities stop paying when you die. Others pay a beneficiary the remaining value or continue payments to a spouse. You choose this when you buy it.

Can I get my money back if I change my mind?

Most annuities have a short "free look" period after purchase when you can cancel. Check your contract for the exact length. After that, you're subject to the surrender period and its charges.

Related terms

• 401(k)
• Compound interest
• Index