Simple answer: An annuity is a contract with an insurance company where you give them money today, and they promise to give you money back later—either as guaranteed growth or as guaranteed income for life.
Think of it as the opposite of life insurance. Life insurance pays your family when you die. An annuity pays you while you're alive. It's designed to solve one specific problem: making sure you don't run out of money in retirement, no matter how long you live.
At its core, an annuity is a risk transfer mechanism. You're transferring the risk of living "too long" to an insurance company. If you live to 100, they keep paying. If you die at 70, they might keep the remaining balance (depending on the contract type).
This matters because longevity risk is one of the biggest threats to retirement security. With life expectancies increasing and traditional pensions disappearing, more Americans face the prospect of outliving their savings. According to the Society of Actuaries, a 65-year-old couple has a 50% chance that at least one spouse will live to age 92.
Annuities address this by pooling risk across thousands of people—the same way all insurance works. Some people die early (the insurance company keeps their surplus), others live a very long time (the company pays out more than they contributed), and the pool balances out.
Here's the basic flow of an annuity contract:
Most annuities have two distinct phases:
This is crucial to understand: annuities are issued by life insurance companies, not investment firms. They're regulated by state insurance departments, not the SEC (except for variable annuities).
The goal isn't to beat the stock market or maximize returns. The goal is to provide guarantees—guaranteed growth rates, guaranteed income, or both. You're paying for certainty, not upside potential.
Like a 401(k) or IRA, earnings inside an annuity grow without annual taxation. You only pay taxes when you take money out. This can be powerful for long-term compounding, especially if you've maxed out other tax-advantaged accounts.
However, withdrawals are taxed as ordinary income (not capital gains), which can be a disadvantage compared to holding stocks in a taxable brokerage account.
Different annuity types offer different guarantees:
The strength of these guarantees depends on the financial strength of the issuing insurance company, which is why carrier ratings matter.
Annuities aren't a modern invention. The concept dates back to the Roman Empire, where citizens paid a lump sum to receive "annua"—annual payments for life or for a set number of years.
Modern annuities emerged in the 1700s when European governments used them to raise funds for wars and public projects. Churches and universities used annuities to fund operations in exchange for lifetime payments to donors.
In the United States, annuities became widely available through life insurance companies in the late 1800s. The first variable annuity was created in 1952, fixed index annuities appeared in 1995, and newer products like RILAs (Registered Index-Linked Annuities) launched in the 2010s.
Today, the annuity market is massive—over $340 billion in premiums were paid in 2023. Baby boomers retiring without traditional pensions have driven much of this growth.
Annuities are exclusively issued by life insurance companies. This includes big names like:
These companies are regulated at the state level, not federally. Each state has its own insurance department that oversees solvency, sales practices, and consumer protection.
Financial strength matters. Look for companies with strong ratings from agencies like AM Best (A+ or A++), Moody's (Aa3 or higher), or S&P (AA- or higher). These ratings indicate the company's ability to pay claims decades into the future.
If an insurance company fails, state guaranty associations provide backup protection—typically covering $250,000 in present value per person. This isn't as strong as FDIC insurance for banks, but it's rare for highly-rated insurers to fail.
Key Point: Annuities solve one specific problem exceptionally well—running out of money in retirement. They're not designed to maximize returns or beat the market. If that's your goal, stick with low-cost index funds. But if you value guaranteed income and sleep-at-night security, annuities can be a powerful tool.
Sarah, age 65, has $300,000 she wants to convert into guaranteed lifetime income. She buys an immediate annuity (SPIA) from a highly-rated insurance company. In exchange for her $300,000 premium, they guarantee her $1,800 per month for the rest of her life—no matter how long she lives.
Let's do the math:
If she dies at age 70 (5 years of payments), she would have received only $108,000—and the insurance company keeps the remaining $192,000. To protect against this, she could have chosen a "cash refund" or "period certain" option, which costs slightly more and reduces monthly income but provides death benefits.
This is the insurance trade-off: you're betting you'll live longer than average, and the insurance company is betting you won't. Because they pool thousands of people, both parties can win.
While we'll cover each type in depth in other articles, here's a quick overview:
Let's clear up some misconceptions:
An annuity is a contract that converts savings into guaranteed growth, guaranteed income, or both. It's a tool for managing longevity risk—the risk of outliving your money.
Annuities aren't for everyone. They have trade-offs: less liquidity, potentially lower returns than stocks, and complexity. But for the right person at the right time, they can provide irreplaceable peace of mind.
The key is understanding what problem you're trying to solve. Need guaranteed income you can't outlive? An immediate or deferred income annuity might fit. Want CD-like safety with better rates? Consider a MYGA. Want market participation with downside protection? A fixed index annuity could work.
The rest of this wiki will help you understand the mechanics, know when annuities make sense, and—just as importantly—when they don't.