What Is an Annuity?

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An annuity is a contract where an insurance company agrees to pay the holder of the annuity, either in a lump sum or through regular payments over time; an “immediate annuity” indicates that payments begin immediately, whereas a “deferred annuity” indicates that payments begin sometime in the future.

Definition and Examples of Annuities

Annuities are retirement products and they receive special tax treatment: Premiums deposited into an annuity grow tax deferred until the owner takes withdrawals or annuitizes the funds. They are also  a type of insurance product where the insurer agrees to make payments to the buyer, either immediately or sometime in the future.

They can be purchased with either a single premium payment, or a series of premium payments, and, depending on how soon you want to receive income, are available in two types: deferred and immediate. 

  • Deferred annuities: This type of annuity has two phases, accumulation and income. During the accumulation phase, you contribute funds to the annuity, and they accumulate on a tax-deferred basis. During the income phase, you have the option to “annuitize” those funds—meaning you exchange the lump-sum value of the annuity for a stream of guaranteed payments, such as lifetime income—or to make withdrawals, without annuitizing. Through withdrawals, you retain access to the lump sum value.
  • Immediate annuities: Immediate annuities begin to pay an income shortly after the premium is paid in exchange for a lump sum payment, which is no longer accessible.


Because they’re a retirement product, early withdrawals—typically prior to 59 1/2—will trigger a 10% penalty in addition to income tax.

If annuitized, the income paid out is calculated based on the age and sex of the annuitant, selected by the owner, and the duration of payments. The annuitant and the owner can be the same person, but they don’t have to be. 

In addition to being either deferred or immediate, annuities are non-qualified or qualified. Qualified annuities are part of a pension plan or IRA. They’re subject to any limits those plans impose and are purchased with before tax dollars. Non qualified annuities are paid for with after tax dollars and are not subject to contribution limits.

Surrender Period

Most deferred annuities have a surrender period, typically the first five to ten years, and cashing in or cancelling your annuity during that time can lead to a hefty surrender charge. This charge declines over time and disappears once the surrender period ends.


Annuities are long term investments. If you need to access the money during the surrender period or prior to age 59 1/2, you could pay substantial penalties.

Annuities can only be sold by licensed life insurance agents. Ensure your agent or advisor is registered with your state's insurance department before you invest. You should also be aware that sellers of most annuity products earn commission for selling them.

Types of Annuities

Annuities are available in three investment styles.


Fixed annuities pay a rate of interest that is guaranteed for a period of time, from one year to the life of the annuity policy. The account value of the annuity is guaranteed by the insurance company. The premiums are invested in the insurance company's general account portfolio of bonds and other investments. Fixed immediate annuities pay a predetermined income to the owner. Fees and expenses for fixed annuities are generally limited to surrender penalties and optional rider charges. Sometimes you may also be charged an annual contract fee, typically around $30.


Variable annuities have a menu of investments to select from that are like mutual funds called sub-accounts. The policy values reflect the performance of the funds and are not guaranteed. Variable immediate annuities pay income to the owner that rises and falls with the value of the funds.

Fees and expenses for variable annuities generally include mortality and expense charges, fund management fees, administration fees, surrender penalties, and optional rider charges. Variable annuity fees and expenses can be 2% or more. 


Indexed annuities have a menu of financial indexes to select from, like the S&P 500, or the Russell 1000. The account value of the annuity is measured by the performance of the index. If the index is positive, a portion of the gain is credited to the account. If the index is negative, the account value remains the same, there are no losses. But while the performance of the account is measured by the index selected, the premiums are invested in the insurance company's general account, not indexed mutual funds.

Indexed annuities may offer investors more upside than fixed annuities while still offering guarantees. Calculating how the gain is credited, however, can be complicated. For example, caps, participation rates, threshold rates, and spread rates are common devices used to limit gains, and they’re frequently used together.


According to FINRA, one of the most confusing features of an index annuity is the method used to calculate the gain in the index to which the annuity is linked. There are several different ways that this can be calculated which makes it difficult to compare one indexed annuity to another.

Fees and expenses for indexed annuities are generally limited to surrender and optional rider charges. Currently, there are no indexed immediate annuities available.

Annuities & Riders

Riders are optional benefits the insurance company offers at an additional cost. Some common riders are:

Guaranteed Minimum Income Benefit (GMIB)

The GMIB rider provides a minimum guaranteed lifetime income at retirement based on a GMIB amount, and not the general  account value. The minimum income is based on the original investment accumulated at an interest rate specified in the policy. Like annuitization, once the option is selected the owner has no access to policy values. The GMIB can be based on one or two people.

Guaranteed Lifetime Withdrawal Benefit (GLWB)

The GLWB rider also provides a minimum amount of lifetime income when you retire regardless of investment performance. Unlike the GMIB, the owner does have access to the account values. Withdrawing money in excess of the withdrawal limit (such as 5%)  will, however, reduce or eliminate the guaranteed income. The GLWB benefit can be based on one or two people.

Guaranteed Minimum Accumulation Benefit (GMAB)

The GMAB rider also guarantees a minimum account value regardless of investment performance. The rider guarantees that you can access a percentage of your premium payments, such as 90% or 100% , after a holding period, such as 5-10 years.

Enhanced Death Benefits

The standard annuity death benefit is the account value. There is no charge for the standard death benefit, but some life insurance companies offer death benefits that step up or increase based on a formula. For example, the rider could periodically “lock in” investment performance or guarantee a death benefit equal to your account value plus a minimum rate of return.


In addition to annual fees, annuities have mortality and expense (M&E) fees, fees for optional riders, and sub-account expenses for variable annuities. Depending on the type of annuity and options selected, fees could run up to 2% or more.

What Does It Mean to Annuitize?

When you annuitize, the insurance company agrees to pay you an income in exchange for a premium (which may be your contract value in the case of a deferred annuity). Once you pay the premium, you have no access to the money. Common annuitization options include:

Life Only

The insurance company agrees to pay income for life. The payments stop whenever the annuitant dies, there is no payment to beneficiaries.

Period Certain and Life

The insurance company agrees to pay income for life or a minimum number of years, whichever is longer. A  life annuity with a 10-year period certain means the insurance company will pay the income for at least 10 years. If you live longer than 10 years, it’ll pay your regular income for life, but if you die during the 10 year period, your beneficiary will receive payments for the remainder of the 10-year term.

Joint And Survivor

The insurance company agrees to pay income for the lifetime of two annuitants – the account holder and the beneficiary. The income stops when the last annuitant alive dies. Since the payments to the survivor are an added benefit, the typical payment amount is lower than that from a life only annuity.


Lifetime payouts are lower for women and couples because they have a longer life expectancy.

While the annuitization rates vary by insurance company and change regularly. Here's an example of how much lifetime income per month $200,000 can buy for a couple aged 65 years.

  Male Aged 65 Female Aged 65 Both
Life Only $ 694 $ 652  --
10 Year Certain And Life $ 682 $ 644  --
Joint & Survivor Life Only -- -- $ 558

Some indexed and variable annuities offer other guaranteed income options called living benefit riders—some of which don't require giving up principal.


Once you annuitize it is usually not possible to reverse that decision. In the rare case that an insurance company allows that, it is extremely expensive. The other option is to sell the annuity, but that typically fetches a deeply discounted price.

Do I Need an Annuity?

The average American will spend 20 years in retirement. In fact running out of money is a top concern for retirees. A deferred or immediate annuity is a way to guarantee a lifetime income whatever interest rates, or market conditions may be.

Generally, deferred annuities are best for people in the 40-65 years age group, with enough liquid investments to cover any immediate needs, unusual expenses, or emergencies. Here are some of the ways you can use them.

Supplement Retirement Savings

If you are contributing the maximum amount to your company sponsored retirement plan, or IRA, a deferred annuity may be a good option because of the favorable tax treatment (the account values of annuities grow tax deferred). There are low cost annuities available on the market that are designed only for accumulation.

Downside Protection

For some investors, the downside protection features of indexed annuities or variable annuities may be attractive. Variable and indexed annuities offer a variety of living benefit riders to protect retirement income and principal from down markets. Death benefit riders can protect the value of the annuity for beneficiaries as well.

Lifetime Retirement Income

There are only three sources of a guaranteed lifetime income: pensions, social security, and annuities. If you are concerned about potentially running out of money later in retirement, annuities can provide a foundation for income. You can use your IRA or in some cases 401k to fund the annuity, as well as non-qualified money.

Estate Planning

Proceeds from an annuity death benefit pass directly to the named beneficiary, avoiding probate. Some annuities offer enhanced death benefit riders which provide additional protection for the beneficiary. Enhanced death benefits can be an attractive option for investors unable to obtain life insurance.


Older investors should be especially careful to review their retirement plan with a financial professional before buying an annuity. 

Alternatives to Annuities

Annuities can be very effective financial tools, but they are long term investments, and may have significant fees and surrender penalties. If you need the money before the surrender penalties expire, or if you don’t need the insurance features, an annuity may not be right for you.

In addition to annuities, qualified retirement plans like Individual Retirement Accounts (IRAs) and 401(k) and 403(b) plans, plus personal brokerage accounts let you invest money in mutual funds, stocks, bonds, CDs, and others. Each has different tax treatment, benefits, and limitations. 

  Traditional 401(k), 403(b) Traditional IRA Roth 401(k) 403(b), IRA Non Qualified Annuity  Personal Savings Accounts
Investment Menu Stock market investments limited by employer's plan, but often many options available. Stock market investments. Life insurance, collectibles, and certain derivatives prohibited. Same as traditional Mutual funds, index, fixed interest rate Unlimited 
Contributions Taxable No No Yes Yes  Yes
Contributions Limited Yes Yes Yes No No
Tax on gains, interest, dividends No No No No Yes
Withdrawals taxable 100% at ordinary rates 100% at ordinary rates No Gains are taxed at ordinary rates. No tax on withdrawal of principal No 
Early withdrawal penalties Yes Yes Yes, once withdrawals exceed contributions Yes  No
Creditor Protection Federal Federal up to 1 million Same as traditional By State  No

Annuities have features other retirement vehicles don't: They can provide lifetime income, and indexed and variable annuities can protect savings against market downturns. For these reasons, they may be more expensive as well. If you think an annuity might be appropriate for your savings or income goals, don't hesitate to ask questions of your financial advisor or insurance agent before buying. And be sure you understand the total annual cost of your policy, including the individual cost and protection features of any riders you're considering adding.

Key Takeaways

  • Annuities are insurance products that offer investment returns immediately or at a future date. 
  • While there can be many customized products, there are three basic types of annuities– fixed, variable and indexed.
  • Annuities are popular because they offer a combination of guarantees and tax benefits that may not be available in other products. 
  • Annuities can become expensive, especially on account of commissions, cost of add-on riders, and surrender charges.
  • Annuities can be very effective financial tools, but they're not for everyone.
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The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. Internal Revenue Service. “Publication 575 (2020), Pension and Annuity Income.” Accessed April 19, 2021.

  2. Investor.gov U.S. Securities and Exchange Commission. “Variable Annuity Surrender Charges.” Accessed April 19, 2021.

  3. Edward Jones. “Annuities.” April 19, 2021.

  4. FINRA. "Variable Annuities: Beyond the Hard Sell." Accessed April 19, 2021.

  5. FINRA. "Indexed Annuities." Accessed April 19, 2021.

  6. Citi Personal Wealth Management. “An Overview of Annuities.” Accessed April 19, 2021.

  7. Social Security Administration. “Social Security Retirement Benefits and Private Annuities: A Comparative Analysis.” Accessed April 19, 2021.

  8. Standard Insurance Company. “Your Annuity Contract.” Accessed April 19, 2021.

  9. Insurance Information Institute. “How are annuities different from life insurance?” Accessed April 19, 2021.

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