What is an annuity? A plain-English guide for retirees.

What is the core trade inside every annuity?

Every annuity comes down to one trade. You hand an insurance company money you agree not to take back freely, and the insurer hands you a promise: a stream of income on a schedule you choose, which can be guaranteed to continue for as long as you live. You are buying certainty with flexibility.

The reason an insurer can promise lifetime income is pooling. Among thousands of annuity owners, some will collect for a short time and some for decades, and the insurer prices the promise across the whole group. That is the same logic that makes homeowners insurance work, applied to the risk of a very long life. If dependable monthly income is the part that interests you most, our guide to guaranteed lifetime income goes deeper on how the paycheck itself is built.

Any guarantee is backed by the claims-paying ability of the issuing insurer; it is not FDIC-insured or bank-guaranteed.

How do the accumulation and payout phases work?

Most annuities move through two phases. In the accumulation phase, your money sits inside the contract and grows tax-deferred, meaning you owe no tax on the growth until you take it out. In the payout phase, the flow reverses: the insurer sends money to you, as scheduled withdrawals, rider income, or annuitized payments.

Two important exceptions and caveats. First, an immediate annuity skips accumulation entirely; income starts within about a year of your deposit. Second, tax-deferred never means tax-free. Gains come out first and are taxed as ordinary income, and withdrawals before age 59½ may add a 10% federal penalty. How that interacts with Social Security, required minimum distributions, and your bracket is covered in our guide to the retirement tax picture.

What are the main families of annuities?

Four families cover nearly every annuity a retiree is likely to be shown. Each answers a different question, which is why "should I buy an annuity" is really "which job, if any, do I need done."

All guarantees in every family are backed by the claims-paying ability of the issuing insurer and are not FDIC-insured. Variable annuities exist as securities products with market risk; they are outside the scope of this site, which covers fixed and fixed-indexed products only. For the full tour of each family, see types of annuities explained.

What is an annuity not?

Half the trouble people have with annuities comes from judging them as something they are not. Three corrections do most of the work.

Who do annuities suit, and who should walk away?

An annuity is a tool, and tools fit hands, not headlines. As a rule, annuities earn their keep when dependable income is the gap in your plan, and they disappoint when flexibility or growth is what you actually needed.

For a question-by-question self-check, read is an annuity right for me. And if an advisor pitches indexed universal life as an annuity alternative, know that an IUL is life insurance, not an investment, with its own loan and lapse risks; our IUL guide covers both sides.

What do annuities cost? Fees and surrender charges, honestly.

Annuities are rarely free of cost, even when no fee appears on a statement. Knowing where the costs hide is most of the defense.

Surrender charges. Most deferred annuities carry a surrender schedule lasting several years. Withdraw more than the contract's allowed amount during that window and the insurer keeps a percentage. Many contracts permit a modest annual withdrawal without charge, but the schedule is the price of the guarantee, and it declines over time by design.

Commissions. With most fixed and fixed-indexed annuities you never write a check for the commission. It is built into the product's pricing. That does not make it dishonest, but it can shape what gets recommended, which is why the questions below ask about compensation directly.

Rider fees. Optional benefits such as guaranteed income riders or enhanced death benefits carry annual charges deducted from the contract. A rider can be worth its cost or quietly drain a contract in flat years. Every rider deserves its own yes-or-no decision.

Implicit costs. On fixed-indexed contracts, caps, participation rates, and spreads limit what you are credited, and the insurer can usually reset them within stated bounds. This is how the downside floor is paid for. Nothing about that is scandalous, but it should be said out loud before you sign.

None of this makes annuities bad. It makes them priced. The only question that matters is whether what you get is worth what you give up, for your plan, not someone else's.

What questions should you ask any advisor before you buy?

Take this list to any meeting, ours included. A good advisor will welcome every question on it; a hesitant answer is itself an answer.

1. How are you paid on this product, in plain terms, and would you put that in writing?
2. What is the surrender schedule, year by year, and exactly what would it cost me to leave in the first year?
3. What problem in my plan does this solve that a simpler or cheaper option could not?
4. What are the issuing insurer's financial strength ratings, and from which rating agencies?
5. If this is a fixed-indexed annuity, what are the current caps, participation rates, and spreads, and how often can the insurer change them?
6. What does each rider cost per year, and what precisely triggers its benefit?
7. What happens to this contract when I die, and what does each survivor option cost me in income?
8. If I do nothing for a year and think it over, what do I lose?

Prefer to watch first?

"The Descent," our short education film

Why retirement's riskiest years come after you stop working, and the honest way to weigh each risk. About twenty minutes, plainly labeled Annuity Explained education.

Watch the film →