What is an Annuity?
An annuity is a contract between you and an insurance company where you invest a lump sum (or series of payments) in exchange for either guaranteed growth or guaranteed income—or both.
At its core, an annuity is designed to solve one fundamental problem: outliving your money. It's essentially longevity insurance that converts your savings into reliable cash flow.
How Annuities Work: The Simple Version
- You invest money with a highly-rated insurance company
- The insurance company guarantees either a rate of return (growth) or income payments
- You choose the structure that fits your goals (growth, income now, or income later)
- Your principal is protected by the insurance company's financial strength and state guaranty funds
- Tax-deferred growth means you don't pay taxes on gains until withdrawal
Why Do Annuities Exist?
Longevity Insurance
With people living 20-30 years in retirement, traditional savings can run out. Annuities guarantee income for life, no matter how long you live.
Pension Replacement
As defined-benefit pensions disappear, annuities provide the same guaranteed monthly income that pensions once offered.
Market Protection
For conservative investors who can't afford to lose principal during market downturns, annuities provide guaranteed returns.
Tax Deferral
Unlike taxable savings accounts, annuities grow tax-deferred. You only pay taxes on gains when you withdraw, potentially in a lower tax bracket.
The Insurance Company's Role
When you buy an annuity, you're essentially transferring risk to an insurance company. They're betting they can invest your money wisely and still meet their guarantees. You're betting they'll stay solvent and honor those guarantees. That's why carrier financial strength ratings (like AM Best A+ ratings) matter so much.
Annuity Types Overview
Annuities come in five main variations, each designed for different goals. The three core types are Fixed Index Annuities (FIA) for growth with protection, Multi-Year Guaranteed Annuities (MYGA) for predictable returns, and Single Premium Immediate Annuities (SPIA) for instant income. Deferred Income Annuities (DIA) and Registered Index-Linked Annuities (RILA) offer specialized variations for specific needs. Compare them side-by-side →
Visual Overview
Five main types of annuities, each designed for different goals
Core Types
Fixed Index Annuity
Tax-deferred growth with market upside and downside protection
Tax-deferred growth with market upside and downside protection
Growth-oriented individuals wanting principal protection
Variable (3-8% annually)
5-10 years
Multi-Year Guaranteed
Guaranteed fixed rate, like a long-term CD
Guaranteed fixed rate, like a long-term CD
Conservative savers wanting guaranteed returns
Fixed (4.5-6% annually)
3-10 years
Immediate Income
Immediate guaranteed lifetime income
Immediate guaranteed lifetime income
Retirees needing income now
None (converts to income)
Lifetime
Specialized Variations
Deferred Income
Future guaranteed income at a set age
Deferred lifetime income starting at a future date
Longevity insurance for later retirement years
Higher payouts (8-12% annually)
Lifetime (starts 5-30 years later)
RILA (Buffer)
Unlimited upside with buffer protection
Uncapped market growth with downside buffer
Investors wanting more upside than FIAs with limited downside risk
Uncapped (100% of index gains possible)
6 years
When Annuities Make Sense
Annuities aren't for everyone, but they can be powerful tools in the right situations. Here are scenarios where annuities typically make good financial sense.
You Need Guaranteed Retirement Income
If you're worried about outliving your savings or want to replace a pension you never had, annuities provide guaranteed income for life—no matter how long you live or what the market does.
You Want a CD Alternative with Better Rates
MYGAs often pay 0.5-1.5% more than bank CDs with similar safety. If you don't need immediate liquidity and want guaranteed returns, MYGAs are worth comparing.
You're Conservative and Can't Afford Market Losses
If a market crash would derail your retirement plans, FIAs offer growth potential with zero downside risk. Your principal is always protected.
You Have Maxed Out Other Tax-Advantaged Accounts
Already maxing out your 401(k) and IRA? Non-qualified annuities offer unlimited tax-deferred growth with no annual contribution limits.
You Want to Cover Essential Expenses in Retirement
Use annuity income to cover non-negotiable expenses (housing, food, healthcare) while keeping other investments for discretionary spending.
You're Laddering Fixed-Income Investments
Building a CD ladder? Consider including MYGAs of different terms for potentially higher rates and tax deferral benefits.
You Want Longevity Insurance
Worried about living to 95 or 100? Annuities are the only financial product that guarantees income no matter how long you live. That's literally what they're designed for.
You Have a Pension Gap
If you need $5,000/month in retirement but only have $3,000 from Social Security and pensions, an annuity can fill that $2,000 gap with guaranteed income.
You Want to Leave a Legacy with Protection
Many annuities include death benefit riders that guarantee your heirs receive at least what you put in, even if you haven't taken income yet.
You're Within 5-10 Years of Retirement
You're in the "red zone" where a market crash could devastate your plans. FIAs let you participate in gains while protecting against losses during this critical period.
When to Avoid Annuities
Annuities are powerful tools, but they're not appropriate for every situation. Here's when you should probably skip them.
You Need Liquidity Soon (Within 1-2 Years)
Annuities have surrender charges for early withdrawal. If there's any chance you'll need this money in the near term, keep it in liquid savings or investments instead.
You Don't Have an Emergency Fund
Never put money into an annuity until you have 6-12 months of expenses in liquid emergency savings. Annuities are for long-term money, not emergency funds.
You Don't Fully Understand the Product
If you can't explain the caps, participation rates, and surrender charges to a friend, you shouldn't buy it. Never invest in what you don't understand.
You Have High-Interest Debt
Paying off credit card debt at 20% APR is a guaranteed "return" better than any annuity. Eliminate high-interest debt before considering annuities.
You're Very Young (Under 40)
With decades until retirement, you can afford market volatility and should prioritize growth investments. Annuities are better suited for those closer to or in retirement.
You Want Maximum Growth Potential
Annuities trade growth potential for safety. If you have a long time horizon and want maximum returns, traditional investments (stocks, index funds) are more appropriate.
You're Being Pressured by a Salesperson
High-pressure sales tactics ("this offer expires today!") are red flags. Legitimate annuities will still be available tomorrow. Never rush this decision.
The Fees Are Excessive
Be wary of annuities with annual fees over 2%, especially FIAs with expensive income riders you may not need. Simpler products often perform better after fees.
You Haven't Shopped Around
Rates and terms vary dramatically between carriers. If you're only looking at one product from one company, you're probably leaving money on the table.
Your Time Horizon Is Too Short
Annuities work best over 5+ years. With shorter timeframes, the surrender charges and opportunity cost outweigh the benefits. Use CDs or money market funds instead.
Glossary of Common Terms
Understanding annuity terminology is essential for making informed decisions. Here are the key terms you need to know.
Accumulation Phase FIA MYGA
The period when your annuity is growing in value before you start taking income. During this phase, your money earns interest or growth credits.
AM Best Rating ALL TYPES
An independent rating of an insurance company's financial strength. A+ (Superior) and A++ (Superior) are the highest ratings and indicate strong ability to meet obligations.
Annuitization SPIA
The process of converting your annuity's value into a stream of income payments. With SPIAs, this happens immediately. With FIAs and MYGAs, it's optional at the end of the term.
Cap Rate FIA
The maximum interest rate you can earn in a crediting period, regardless of how well the index performs. Example: With an 11% cap, if the S&P 500 gains 15%, you receive 11%.
Carrier ALL TYPES
The insurance company that issues the annuity contract and is responsible for meeting all guarantees.
Crediting Method FIA
The formula used to calculate your interest credits based on index performance. Common methods include annual point-to-point, monthly averaging, and monthly cap.
Death Benefit ALL TYPES
The amount paid to your beneficiaries upon death. Typically the account value (for FIA/MYGA) or remaining guaranteed payments (for SPIA). Some contracts include enhanced death benefits.
Fixed Rate MYGA
The guaranteed interest rate you'll earn for the entire term of a MYGA. This rate is locked in at purchase and never changes.
Free Withdrawal FIA MYGA
The amount you can withdraw each year without incurring surrender charges. Typically 10% of account value annually after the first contract year.
Guaranteed Minimum Withdrawal Benefit (GMWB) FIA
An optional rider that guarantees you can withdraw a certain percentage of your initial investment annually for life, regardless of account performance.
Income Rider FIA
An optional add-on that provides guaranteed lifetime income, typically starting after a waiting period. These usually have annual fees of 0.5-1.5%.
Index FIA
The market benchmark (like S&P 500) that your FIA's interest credits are based on. You're not directly invested in the index—you earn credits based on its performance.
Joint Life SPIA
A payout option where income continues until both you and your spouse die. Payments are lower than single life but provide more security for couples.
Liquidity ALL TYPES
How easily you can access your money. Annuities generally have limited liquidity due to surrender charges, though most allow some penalty-free withdrawals.
Market Value Adjustment (MVA) MYGA
An adjustment (positive or negative) applied to early withdrawals based on interest rate changes. If rates rise, your withdrawal value decreases. If rates fall, it increases.
Participation Rate FIA
The percentage of index gains you receive. A 100% participation rate means you get all the gain (up to the cap). A 50% rate means you get half the gain.
Payout Rate SPIA
The percentage of your premium that's paid out annually as income. Example: A 7% payout rate on $100,000 means $7,000/year. Higher rates for older purchasers.
Period Certain SPIA
A guaranteed minimum payment period (e.g., 10 or 20 years). If you die early, payments continue to your beneficiary until the period ends.
Premium ALL TYPES
The initial amount you invest to purchase the annuity. Most annuities have minimums ranging from $5,000 to $25,000.
Principal Protection FIA MYGA
Your initial investment is protected from market losses. Even if the linked index crashes, your account value never decreases due to market performance.
Qualified vs Non-Qualified ALL TYPES
Qualified annuities are funded with pre-tax IRA or 401(k) money. Non-qualified annuities are funded with after-tax dollars. This affects taxation at withdrawal.
Renewal Rate MYGA
The rate offered when your MYGA term ends. This is typically lower than initial rates, so many people shop for a new MYGA instead.
Rider ALL TYPES
An optional add-on feature that provides additional benefits, usually for an annual fee. Common riders include income guarantees, enhanced death benefits, and nursing home waivers.
State Guaranty Fund ALL TYPES
State-run programs that provide limited protection (typically $250,000) if an insurance carrier fails. This is separate from FDIC insurance but serves a similar purpose.
Surrender Charge FIA MYGA
A penalty for withdrawing more than the free withdrawal amount before the surrender period ends. These typically start at 8-10% and decline annually to zero.
Surrender Period FIA MYGA
The number of years during which surrender charges apply if you withdraw more than the free withdrawal amount. Common periods are 5-10 years.
Tax Deferral ALL TYPES
You don't pay taxes on interest or growth until you withdraw it. This allows your money to compound faster than in taxable accounts.
Term MYGA
The length of time your MYGA's guaranteed rate is locked in. Common terms are 3, 5, 7, and 10 years.
1035 Exchange ALL TYPES
A tax-free transfer from one annuity to another. Named after IRS code section 1035, this allows you to move to a better product without triggering taxes.
Common Questions (FAQ)
Get straight answers to the most frequently asked questions about annuities.
Are annuities safe?
Annuities are as safe as the insurance company backing them. This is why financial strength ratings matter. Stick with carriers rated A+ or higher by AM Best, and your annuity is backed by one of the most regulated industries in America. State guaranty funds also provide additional protection (typically up to $250,000 per carrier). From a principal protection standpoint, FIAs and MYGAs guarantee you won't lose money due to market downturns.
What happens if the insurance company fails?
Insurance companies are heavily regulated and failures are extremely rare. If a carrier does fail, state guaranty associations step in to protect policyholders (typically covering $250,000 per person per company). Additionally, failed carriers are usually acquired by stronger companies who assume the obligations. This is why buying from highly-rated carriers (A+ or better) is crucial.
Can I get my money back?
Yes, but timing matters. With FIAs and MYGAs, you can typically withdraw up to 10% annually without penalties, or surrender the entire contract (subject to surrender charges during the surrender period). After the surrender period, you have full access. SPIAs are different—once annuitized, you've traded your lump sum for guaranteed income and generally can't reverse that decision.
How are annuities taxed?
It depends on whether the annuity is qualified or non-qualified. Qualified annuities (funded with IRA/401k money) are fully taxable as ordinary income when withdrawn. Non-qualified annuities (funded with after-tax dollars) are taxed only on the gains—your principal comes out tax-free. All growth is tax-deferred until withdrawal. Early withdrawals before age 59½ may incur an additional 10% IRS penalty.
What are surrender charges and how long do they last?
Surrender charges are penalties for withdrawing more than the allowed free withdrawal amount (typically 10% annually) before the surrender period ends. They usually start at 8-10% in year one and decline by about 1% each year until they reach zero. Surrender periods typically last 5-10 years depending on the contract. These charges compensate the insurance company for upfront costs and incentivize you to keep money invested long-term.
Are annuities right for everyone?
Absolutely not. Annuities work best for people who: (1) are within 10-15 years of retirement or already retired, (2) want guaranteed income or principal protection, (3) have already funded emergency savings and other retirement accounts, (4) can commit money for 5+ years, and (5) have a clear goal the annuity addresses. If you're young, need liquidity, or want maximum growth potential, traditional investments are likely better.
How do I choose between FIA, MYGA, and SPIA?
Start with your primary goal: Want growth with protection? FIA. Want simple guaranteed returns like a CD? MYGA. Need income starting now? SPIA. Also consider your time horizon (SPIAs are forever, MYGAs have set terms, FIAs are flexible), risk tolerance (MYGAs are simplest, FIAs have market exposure with protection), and whether you value upside potential (FIA) or certainty (MYGA/SPIA).
Can I lose money in an annuity?
With FIAs and MYGAs, you cannot lose principal due to market performance—these products guarantee your initial investment. However, you can lose money to: (1) surrender charges if you withdraw early, (2) inflation eroding purchasing power, (3) fees for optional riders, or (4) opportunity cost if better investments were available. Variable annuities (which we don't focus on here) CAN lose principal due to market losses.
What's the difference between an annuity and a CD?
Both offer guaranteed returns, but key differences exist: Tax treatment: Annuities are tax-deferred, CDs are taxable annually. Insurance vs. Bank: Annuities from insurance companies, CDs from banks. Protection: CDs have FDIC insurance ($250k), annuities have state guaranty funds ($250k typically). Rates: MYGAs often pay 0.5-1.5% more than comparable CDs. Flexibility: CDs are generally simpler and more liquid.
Do annuities have fees?
MYGAs and SPIAs: Typically zero ongoing fees—all costs are built into the rate or payout calculation. FIAs: Base product usually has no annual fee, but optional riders (like income guarantees) cost 0.5-1.5% annually. There are no management fees like mutual funds charge. Surrender charges apply to early withdrawals but these aren't annual fees—they're one-time penalties for breaking the contract early.
Can I add money to an annuity after purchase?
Most FIAs and MYGAs are single premium contracts—you invest once at purchase. Some carriers offer flexible premium deferred annuities that allow additional contributions, but these are less common and may have different terms. If you want to invest more, you typically buy a new contract. SPIAs always require a single premium upfront since they convert immediately to income.
What happens to my annuity when I die?
FIAs and MYGAs: Before annuitization, the account value goes to your named beneficiaries (often with minimal or no death benefit enhancement). They typically must withdraw the funds within 5 years or take lifetime payments. SPIAs: Depends on your payout structure. Life-only means payments stop at death. Period certain continues payments to beneficiaries for the guaranteed period. Joint life continues until the second person dies.
Annuity Myths vs Facts
Let's debunk common misconceptions and set the record straight about annuities.
MYTH: Annuities are a scam
FACT: Annuities are legitimate insurance products regulated by state insurance departments. They've existed for centuries and manage over $3 trillion in the U.S. alone. However, they can be sold improperly—which is why education and working with reputable advisors matters. The product isn't a scam; pushy sales tactics sometimes are.
MYTH: You lose all your money if you die early
FACT: With FIAs and MYGAs, your beneficiaries receive at least the account value (often more with death benefit riders). With SPIAs, you can choose "period certain" or "joint life" options that guarantee payments continue to beneficiaries. Only "life-only" SPIA options stop payments at death—and those pay the highest rates because of that risk.
MYTH: All annuities have high fees
FACT: MYGAs and SPIAs typically have ZERO ongoing fees. Basic FIAs also have no annual fees. Fees only appear when you add optional riders (income guarantees, enhanced death benefits) which typically cost 0.5-1.5% annually. Unlike variable annuities (which can have 3%+ fees), fixed annuities are generally fee-efficient.
MYTH: You can never access your money
FACT: Most FIAs and MYGAs allow 10% penalty-free withdrawals annually after the first year. Many also waive surrender charges for nursing home confinement, terminal illness, or death. After the surrender period (5-10 years), you have full access. The liquidity restriction is temporary, not permanent (except for SPIAs, which intentionally convert to income).
MYTH: Annuities are only for old people
FACT: While annuities are most common among retirees, they can make sense for anyone seeking principal protection or tax-deferred growth. That said, younger investors (under 40) usually benefit more from growth-focused investments with longer time horizons. The ideal age range is typically 50-75, when retirement planning becomes more urgent.
MYTH: You're better off just investing in the stock market
FACT: This depends entirely on your situation. If you're 30 with decades until retirement, yes—stocks likely make more sense. But if you're 65 and can't afford to lose 30% in a market crash right before retirement, principal protection becomes valuable. The best approach is usually a diversified portfolio that includes both growth investments AND guaranteed income sources.
MYTH: Annuities are too complicated to understand
FACT: MYGAs and SPIAs are actually quite simple—simpler than many investment products. MYGAs work exactly like CDs. SPIAs are straightforward income calculations. FIAs are more complex with caps and participation rates, but once you understand the basics (which this guide explains), they're not rocket science. If someone can't explain an annuity clearly, that's a red flag about the salesperson, not the product.
MYTH: Insurance companies always fail to deliver
FACT: Insurance companies are among the most financially stable institutions in America. They're required to hold substantial reserves and are heavily regulated. Failures are rare, and when they happen, state guaranty funds and acquisitions by stronger carriers typically protect policyholders. The key is choosing highly-rated carriers (A+ or better).
Decision Framework: Which Annuity Type Is Right for You?
Use this simple decision tree to identify which annuity type (if any) aligns with your goals.
Start Here: Do You Need Income or Growth?
→ I need income starting NOW (within 1 year)
Product Recommendation: Single Premium Immediate Annuity (SPIA)
Best if:
- You're retiring now and need guaranteed monthly income
- You want to replace a pension you never had
- You have a lump sum to convert to reliable cash flow
- Longevity insurance is your primary concern
→ I want GROWTH but with principal protection
Product Recommendation: Fixed Index Annuity (FIA)
Best if:
- You're 5-15 years from retirement
- You want market upside without downside risk
- You're considering an income rider for future guaranteed income
- You want growth potential better than CDs but safer than stocks
→ I want SIMPLE, GUARANTEED returns (like a CD)
Product Recommendation: Multi-Year Guaranteed Annuity (MYGA)
Best if:
- You have cash sitting in low-interest savings
- You're comparing CD rates and want better returns
- You want tax-deferred growth on safe money
- You can commit funds for 3-10 years
Additional Considerations
Time Horizon Guide
| Less than 3 years | Annuities generally not suitable. Use savings/money market instead. |
| 3-5 years | MYGA (short-term) could work if rates are competitive |
| 5-10 years | FIA or MYGA both appropriate depending on growth vs. safety preference |
| 10+ years / Lifetime | FIA (with income rider), SPIA for immediate income, or DIA for future guaranteed income |
Risk Tolerance Guide
| Very Conservative | MYGA or SPIA - fully guaranteed, zero market exposure |
| Moderately Conservative | FIA - principal protected with market upside potential |
| Moderate | RILA - uncapped growth with buffer protection (10-20% downside buffer) |
| Moderate to Aggressive | Annuities probably not ideal; consider traditional investments for growth |
The Honest Truth: Maybe You Don't Need an Annuity
If you're young (under 45), have a long time horizon, don't need guaranteed income, and are comfortable with market volatility, traditional investment accounts (index funds, ETFs, target-date funds) are probably better. Annuities shine for people closer to or in retirement who can't afford principal losses and value guaranteed income over maximum growth. There's no shame in deciding an annuity isn't right for you—that's often the smart choice.
Ready to Learn More?
Explore our comprehensive guides for each annuity type
FIA Deep Dive
Comprehensive guide to Fixed Index Annuities covering:
MYGA Deep Dive
Everything you need to know about Multi-Year Guaranteed Annuities:
SPIA Deep Dive
Master Single Premium Immediate Annuities with coverage of:
DIA Deep Dive
Deferred Income Annuities for future guaranteed income:
RILA Deep Dive
Registered Index-Linked Annuities with buffer protection:
Still Have Questions?
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