What Is an Annuity? The Complete Guide (2026)

An annuity is a contract between you and an insurance company. You hand over a lump sum — or make a series of payments — and the insurer promises to return it with interest, either as a guaranteed rate or as a stream of income payments.

That’s the core idea. But “annuity” covers five very different products. A MYGA paying 5.75% for five years is an annuity. A variable annuity tied to the S&P 500 with a 2.5% annual fee is also an annuity. They share a legal structure but serve completely different purposes.

This guide breaks down every type, explains who should and shouldn’t consider one, and gives you the questions to ask before handing over a dollar.

What Is an Annuity, Exactly?

An annuity is an insurance product — not a bank account, not a mutual fund. The company you buy it from is a licensed insurance company, and your money is backed by that company’s claims-paying ability.

The fundamental trade-off: you give up some liquidity and flexibility in exchange for guarantees. Depending on the type, that guarantee might be a fixed interest rate, principal protection, or income you cannot outlive.

Annuities are the only financial product that can guarantee lifetime income — which is why they play a central role in retirement planning for millions of Americans.

How Does an Annuity Work?

Every annuity goes through two phases.

During the accumulation phase, your money grows — either at a fixed rate, tied to a market index, or through investment subaccounts. Interest compounds tax-deferred, meaning you don’t owe the IRS anything until you take a withdrawal.

During the distribution phase, you take income. That might be a lump sum, periodic withdrawals, or a guaranteed monthly payment for life.

The insurer invests your premium — mostly in investment-grade corporate bonds and Treasuries — and credits you a portion of the return. That’s why annuity rates track U.S. Treasury yields closely: when the 10-year Treasury is at 4.5%, MYGA and fixed annuity rates tend to be strong.

The 5 Types of Annuities: How Each One Works

1. Fixed Annuity

A fixed annuity pays a guaranteed interest rate, typically for one year, then resets annually based on current market conditions. Think of it like a bank CD issued by an insurance company, with one major advantage: growth is tax-deferred.

Current fixed annuity rates range from 3.50% to 5.50% depending on the carrier and your state.

Best for investors who want predictable annual growth with no market risk, and who are comfortable with the rate resetting each year.

2. MYGA (Multi-Year Guaranteed Annuity)

A MYGA locks in a fixed interest rate for a set term — typically 3, 5, 7, or 10 years. No annual resets. Whatever rate you secure at purchase, you earn it for the entire term.

Example: Robert, age 65, puts $200,000 into a 5-year MYGA at 5.65%. At maturity, his account value is $263,797 — guaranteed, regardless of what the stock market does.

Today’s top MYGA rates run from 5.40% to 5.90% depending on the term. Compare today’s best MYGA rates →

Best for: Conservative investors who want the best available guaranteed rate and don’t need the money for the term period.

3. Fixed Index Annuity (FIA)

A fixed index annuity ties your interest credits to a stock market index — most commonly the S&P 500 — but with a floor of 0%. Your principal cannot decline due to market losses.

The trade-off: gains are limited by a “cap rate” or “participation rate.” If the S&P 500 gains 22% but your cap is 9%, you earn 9%. If the S&P falls 30%, you earn 0%.

Example: Linda, age 61, puts $150,000 in an FIA with a 10% annual cap. Over five years with mixed market returns, she earns an average of 6.2% annually — more than a CD, with zero downside risk to principal.

Many FIAs also offer optional income riders that guarantee future withdrawal rates regardless of account performance. Learn more about how fixed index annuities work →

4. Variable Annuity

A variable annuity lets you invest in mutual fund-like “subaccounts” that rise and fall with the market. Your returns — and your account value — are not guaranteed.

Variable annuities can make sense in specific situations, particularly for high-income investors who’ve maxed out all other tax-advantaged accounts. But the fee structure demands scrutiny. Mortality and expense (M&E) fees typically run 1.0–1.5% annually. Add investment management expenses and optional rider charges, and total annual costs can reach 2.5–3.5%.

Those fees compound. A 3% annual drag on a $200,000 portfolio costs roughly $170,000 in lost growth over 20 years.

Full variable annuity guide: fees, risks, and when they make sense →

5. Income Annuities (SPIA and DIA)

Income annuities are the purest form: you hand over a lump sum and receive guaranteed monthly income — either immediately (SPIA) or starting at a future date (DIA).

Example: Carol, age 72, puts $300,000 into a single premium immediate annuity (SPIA). She receives $2,100/month for life. If she lives to 92, she collects $504,000 total — more than she put in. If she lives to 85, she still gets every payment.

The insurer assumes the longevity risk. That’s the deal. Once purchased, you typically cannot access the principal.

DIAs work the same way but start payments at a future date — often used to hedge against running out of money in very late retirement.

Who Should Consider an Annuity?

Annuities work best for people who:

• Are within 5–10 years of retirement, or already retired
• Have maxed out 401(k) and IRA contributions and want additional tax-deferred growth
• Have $50,000 or more to commit without needing access for 5+ years
• Want guaranteed income they cannot outlive
• Are in a high income tax bracket now and expect to be in a lower bracket in retirement

Annuities are generally not a good fit for:

• People under 50 with a long investment horizon and higher risk tolerance
• Anyone who needs liquidity — surrender penalties are real and significant
• People who would need to put their entire net worth into a single annuity
• Anyone already holding significant guaranteed income (Social Security, pension) who doesn’t need more

What Are the Pros and Cons of Annuities?

Advantages

• Tax-deferred growth — no annual 1099 on interest. Your money compounds without annual tax drag.
• Principal protection — fixed, MYGA, and FIA products cannot lose value due to market declines.
• Guaranteed lifetime income — the only financial product that can guarantee you won’t outlive your money.
• No contribution limits — unlike IRAs and 401(k)s, you can put any amount into a non-qualified annuity.
• Death benefit — account value passes to named beneficiaries, typically avoiding probate.

Disadvantages

• Surrender charges — withdrawing money in the first 5–10 years triggers fees, often 7–9% in year one.
• IRS penalty — withdrawals before age 59½ incur a 10% federal penalty on the taxable portion.
• Ordinary income tax on gains — withdrawals are taxed as income, not at the lower capital gains rate.
• Commission-driven sales — agents earn 5–8% commissions, creating incentives to push higher-commission products.
• Complexity — contracts can run 40+ pages. Riders add cost and fine print.

How Much Does an Annuity Cost?

Fixed and MYGA annuities have no explicit purchase fee. The insurance company makes money on the spread between what they earn investing your premium and what they credit to you. You see none of this; it’s built into the rate they offer.

Variable annuities charge explicit annual fees:

• Mortality and expense (M&E) fee: 1.0–1.5%
• Administrative fee: 0.10–0.30%
• Investment subaccount expenses: 0.50–2.0%
• Optional rider charges (income, death benefit, etc.): 0.60–1.50% each

Fixed index annuities typically charge 0% in base fees, but income rider charges of 0.75–1.25% per year are common if you add one.

Are Annuities Safe?

Fixed, MYGA, and fixed index annuities are as safe as the insurance company that issues them — not the FDIC. This is an important distinction.

Every state has a State Guaranty Association that covers annuity owners if an insurance company fails. Coverage limits vary by state but are typically $250,000 per owner per company. Some states, like California and New York, offer higher limits.

Before purchasing, check the carrier’s financial strength rating from AM Best. Stick with carriers rated A- or better. A, A+, and A++ ratings indicate strong financial stability.

Full guide: Are annuities safe? What the guarantees really mean →

How Are Annuities Taxed?

Annuity growth is tax-deferred, not tax-free. The IRS comes calling when you withdraw.

For non-qualified annuities (funded with after-tax money): withdrawals come out interest-first under the LIFO (last-in, first-out) rule. The growth portion is taxed as ordinary income. Your original principal comes back tax-free.

For qualified annuities (held inside an IRA or 401(k)): 100% of withdrawals are taxed as ordinary income since contributions were pre-tax.

Withdraw before age 59½ and you owe the IRS an additional 10% penalty on the taxable portion, on top of regular income tax.

Complete annuity tax guide: how withdrawals, income, and inherited annuities are taxed →

How to Buy an Annuity: 5 Steps

1. Define your goal. Accumulation (grow money safely) or income (guaranteed payments for life)? This determines the product type.
2. Compare multiple carriers. For MYGAs, rates can vary by 0.75–1.00% between carriers for the same term. That difference on $200,000 over 5 years is roughly $8,500.
3. Verify carrier financial strength. A-rated or better from AM Best. Never buy from an unrated carrier.
4. Read the surrender schedule. Know exactly how many years your money is committed and what the exit penalty is each year.
5. Understand the full contract. Ask for the actual contract, not just the product brochure. Pay attention to free withdrawal provisions (typically 10% per year penalty-free).

Step-by-step guide: how to buy an annuity without overpaying →