Key Takeaways
- An annuity is an insurance contract that turns a lump sum into a guaranteed income stream — for a set period or for life.
- The four main types are fixed, fixed indexed, variable, and immediate annuities. Each serves a different purpose.
- Annuities grow tax-deferred, meaning you don’t pay taxes on gains until you withdraw.
- Fixed and MYGA annuities currently pay 4.50%–5.90% — often beating CDs at most banks.
- Annuities are best for people within 10 years of retirement who want to eliminate market risk on a portion of their savings.
An annuity is a contract between you and an insurance company. You hand over a lump sum — or a series of payments — and the insurer promises to grow that money and eventually pay it back to you, either as a future lump sum or as a monthly income stream you can’t outlive.
That last part — guaranteed income you can’t outlive — is what makes annuities different from every other retirement savings vehicle. Your 401(k) can run dry. Your annuity income can’t.
This guide covers everything a first-time buyer needs to know: what annuities are, how each type works, what they cost, and how to decide if one belongs in your retirement plan.
What Is an Annuity, Exactly?
An annuity is an insurance product designed to solve a specific problem: the risk of running out of money in retirement. It’s not a stock, not a bond, not a bank account — it’s a contract with an insurance company backed by that company’s financial strength.
Every annuity moves through two phases:
You can also surrender an annuity for its cash value before annuitizing — though surrender charges may apply in the early years.
What Are the Four Main Types of Annuities?
There are four types, and they work very differently. Choosing the wrong type is one of the most common mistakes buyers make.
Fixed Annuity
A fixed annuity pays a guaranteed interest rate for a set period — typically 1 to 10 years. It works like a CD, but issued by an insurance company instead of a bank. You know exactly what you’ll earn before you sign.
A Multi-Year Guaranteed Annuity (MYGA) is the most popular type of fixed annuity. Today’s best 5-year MYGA rates run from 5.00%–5.90% from A-rated carriers. Compare today’s best MYGA rates →
Fixed Indexed Annuity (FIA)
A fixed indexed annuity links your interest credits to a stock market index — like the S&P 500 — but protects you from losses. If the index goes up, you earn a portion of the gain. If it goes down, you earn zero, not a negative number.
FIAs are popular with people who want more growth potential than a fixed annuity but can’t stomach losing money. The tradeoff: your gains are capped or subject to a participation rate. Learn how fixed indexed annuities work →
Variable Annuity
A variable annuity invests your money in mutual-fund-like sub-accounts. Your returns depend on how those investments perform — which means you can gain more, but you can also lose principal.
Variable annuities carry the highest fees of any annuity type and are generally best suited for younger investors with a long time horizon who want tax-deferred growth with guaranteed income rider options. See the full variable annuity guide →
Immediate Annuity (SPIA)
A Single Premium Immediate Annuity (SPIA) starts paying income within 30 days of your deposit. You hand over a lump sum, and the insurance company immediately begins sending you monthly checks — for a period certain or for the rest of your life.
SPIAs are the simplest form of annuity and the most direct way to convert savings into guaranteed lifetime income. A 70-year-old male depositing $200,000 into a life-only SPIA today might receive $1,400–$1,600 per month for life.
How Does an Annuity Work in Practice?
Here’s a concrete example. Mary is 62 years old and has $150,000 sitting in a savings account earning 4.50% at her bank. She’s worried rates will drop when her CD renews.
She moves $100,000 into a 5-year MYGA at 5.60%. At the end of 5 years, her $100,000 has grown to about $131,700 — completely guaranteed, with no market risk. She keeps the other $50,000 liquid for emergencies.
At age 67, she can either roll the $131,700 into a new MYGA, convert it to a lifetime income stream, or take the lump sum. She never had to watch the stock market or worry about a bank failure. The insurer’s guaranty association in her state protects up to $250,000 of annuity value.
What Are Annuity Surrender Charges?
Surrender charges are the main catch with annuities. If you withdraw more than the allowed amount before the surrender period ends, you pay a penalty — typically 5%–9% in year one, declining to zero by the end of the term.
Most annuities allow you to withdraw 10% of your account value per year without any surrender charge. This is called the free withdrawal provision. But pull out more than that before the term ends, and the charge kicks in.
The lesson: never put money into an annuity that you might need within the surrender period. Annuities are for long-term money — retirement savings you won’t touch for 3–10 years. Full guide to surrender charges and how to avoid them →
How Are Annuities Taxed?
Annuities grow tax-deferred. You don’t pay taxes on the interest or gains each year — only when you withdraw. This lets your money compound faster than a taxable account.
When you do withdraw, the tax treatment depends on whether the annuity is qualified or non-qualified:
- Qualified annuity (funded with IRA or 401k money): 100% of withdrawals are taxed as ordinary income, just like a traditional IRA.
- Non-qualified annuity (funded with after-tax money): Only the earnings are taxed. Your original principal comes back tax-free. The IRS uses the “exclusion ratio” to determine what percentage of each payment is taxable.
If you withdraw before age 59½, a 10% IRS penalty applies on top of regular income tax — same as with an IRA. See the complete annuity tax guide →
What Does an Annuity Cost?
Cost varies dramatically by type. Fixed annuities and MYGAs have no explicit fees — the insurance company earns its margin from the spread between what it earns on investments and what it pays you. You see a clean rate with no deductions.
Variable annuities are the expensive end: mortality and expense charges (1%–1.5%), sub-account management fees (0.5%–1.5%), and optional rider charges (0.5%–1.5%) can add up to 3%–4% per year. That’s a significant drag on returns.
Fixed indexed annuities fall in the middle. They have no explicit annual fee in most cases, but gains are reduced by caps, participation rates, or spreads built into the crediting formula.
Before buying any annuity, ask the agent to show you the full fee disclosure and the annuity’s projected return under multiple scenarios — including the guaranteed minimum.
What Is the Difference Between an Annuity and a CD?
The most common comparison for fixed annuity buyers. Both lock up your money for a set term and pay a guaranteed rate. But there are important differences:
| Feature | MYGA / Fixed Annuity | Bank CD |
|---|---|---|
| Current 5-year rate | 5.00%–5.90% | 4.00%–4.75% |
| Tax on interest | Deferred until withdrawal | Taxable every year |
| FDIC/NCUA insured | No (state guaranty assoc.) | Yes (up to $250K) |
| Early withdrawal | Surrender charge | Interest penalty |
| Death benefit | Yes — passes outside probate | Goes through estate |
For most retirees in the accumulation phase, the MYGA wins on rate and tax efficiency. For people who prioritize FDIC coverage above all else, the CD wins on safety guarantee. Full MYGA vs CD comparison →
Are Annuities Safe?
Fixed and fixed indexed annuities are among the safest financial products available for retirement savings — not because of government insurance, but because of multiple layers of protection.
Layer 1 — Insurance company reserves: Insurers are required by state law to hold reserves backing 100% of their annuity obligations. They can’t invest your money in speculative assets.
Layer 2 — State guaranty associations: Every state has a guaranty association that steps in if an insurer fails. Most states protect up to $250,000 in annuity value per person per insurer. If you have more than that, split it across two carriers.
Layer 3 — AM Best ratings: Stick with A-rated carriers (A-, A, A+, A++). These insurers have passed rigorous financial strength evaluations. Most reputable annuity comparison tools — including the rate tables on this site — only show A-rated carriers.
The risk isn’t insurer failure — it’s buying the wrong product, paying too much, or locking up money you need liquid. Full guide: Are annuities safe? →
Who Should Buy an Annuity?
Annuities aren’t for everyone. They’re a good fit when:
- You’re within 5–15 years of retirement and want to protect a portion of your savings from market loss
- You’ve maxed out your IRA and 401k and want more tax-deferred growth
- You’re worried about outliving your money and want guaranteed lifetime income
- You want to pass money to heirs outside of probate
- You have a lump sum from a CD, inheritance, or pension rollover and want guaranteed growth
Annuities are a poor fit if you need liquidity in the near term, are already in a high-fee variable annuity (you may be better off doing a 1035 exchange), or are under 50 with decades until retirement and a high risk tolerance.
How Do You Buy an Annuity?
Annuities are sold by licensed insurance agents — either captive agents who work for one company, or independent agents who can shop multiple carriers. Independent agents almost always get you a better deal because they’re not limited to one company’s products.
Never let an agent rush you. A legitimate annuity sale has no deadline. Step-by-step guide to buying an annuity →
Frequently Asked Questions About Annuities
What is the minimum amount needed to buy an annuity?
Most fixed annuities and MYGAs require a minimum of $5,000–$10,000. Some carriers set the minimum at $25,000–$50,000. There’s no maximum. For immediate annuities, $50,000–$100,000 is the practical minimum for meaningful monthly income.
Can you lose money in an annuity?
In a fixed or fixed indexed annuity, you cannot lose principal due to market performance — that’s guaranteed by contract. Variable annuities can lose value if the underlying investments decline. You can also lose value in any annuity if you surrender early and pay surrender charges that exceed your earned interest.
What happens to an annuity when you die?
Most annuities include a death benefit. If you die during the accumulation phase, your named beneficiary receives at least the account value — sometimes more if you purchased an enhanced death benefit rider. Annuity death benefits pass directly to beneficiaries outside of probate, which can save time and legal fees. Learn more about annuity death benefits →
Is an annuity better than a 401(k)?
They serve different purposes. A 401(k) is a tax-advantaged investment account with contribution limits. An annuity is an insurance contract with no contribution limits but surrender charges. Most financial planners recommend maxing your 401(k) and IRA first, then using a non-qualified annuity for additional tax-deferred savings. The two work well together in a retirement income plan.
What is the free-look period on an annuity?
The free-look period is a window — typically 10–30 days after your contract arrives — during which you can cancel the annuity and receive a full refund with no penalties. Free-look periods are required by state law in all 50 states, though the length varies. Full guide to the free-look period →
Do annuities have required minimum distributions (RMDs)?
Qualified annuities held inside a traditional IRA or 401(k) are subject to RMDs starting at age 73, just like any other qualified account. Non-qualified annuities (funded with after-tax money) held outside a retirement account are not subject to RMDs. This makes non-qualified annuities a useful tool for people who want to defer income past age 73.
Are annuities FDIC insured?
No. Annuities are not FDIC insured because they’re issued by insurance companies, not banks. Instead, they’re protected by state guaranty associations — typically up to $250,000 per person per insurer. To maximize protection, stick with A-rated carriers and consider splitting large deposits across two or more insurers if you’re above the guaranty limit.
