Annuity Basics

An annuity is a contract with an insurance company: you pay a premium, and in return the insurer promises a stream of payments — potentially for the rest of your life. Annuities are the main financial product that can insure against outliving your money.

The main types

• Immediate annuities (SPIA): you pay a lump sum and payments begin right away, typically for life.
• Deferred income annuities: purchased now, payments start at a future date you choose.
• Fixed annuities: earn a declared interest rate during accumulation, like a CD issued by an insurer.
• Variable annuities: value fluctuates with underlying investment subaccounts.
• Fixed indexed annuities: returns linked to an index with caps and floors.

The simpler income-focused types (SPIA, deferred income) solve a clear problem; the more complex accumulation types deserve extra scrutiny of costs and terms.

How annuities are taxed

• Inside a taxable purchase, growth is tax-deferred; a portion of each payout is a tax-free return of principal.
• Inside an IRA, an annuity adds no extra tax deferral — the reason to use one there is the income guarantee, not taxes.
• Withdrawals of earnings before age 59½ generally face a 10% penalty on top of ordinary income tax.

What to scrutinize before buying

• Fees: mortality and expense charges, rider fees, and fund costs can stack up in variable products.
• Surrender periods: exiting early can cost several percent for 5–10 years.
• Insurer strength: guarantees are only as good as the company behind them; check financial strength ratings.
• Inflation: a fixed lifetime payment loses purchasing power over decades unless you add (and pay for) inflation adjustment.

Key takeaways

• Annuities convert savings into guaranteed income — insurance against longevity risk.
• Simple income annuities are easier to evaluate than complex accumulation products.
• Fees, surrender terms, and insurer strength determine whether a contract is worth it.

This article is for educational purposes only and is not investment or insurance advice. Consult your advisor about your specific situation.