Home › Annuities
AnnuitiesRetirement IncomePlain EnglishSaving is the climb. Retirement income is the landing.
An annuity is a contract with an insurance company that can protect savings from market losses, grow them tax-deferred, or turn them into income you cannot outlive. Here is how annuities work, what they cost you in flexibility, and how to tell whether one belongs in your plan.
What is an annuity?
An annuity is a contract between you and an insurance company. You give the insurer money, either as one lump sum or over time. In return, the insurer promises one of two things: to grow that money on terms set out in the contract, or to pay it back to you as a stream of income, for a set number of years or for the rest of your life.
Most annuities have two phases. In the accumulation phase, your money sits in the contract and grows without being taxed each year. In the payout phase, you take money out: as withdrawals, as a guaranteed income stream, or as a lump sum.
Because an insurance company issues it, an annuity's guarantees are only as strong as that company. That is why every guarantee you will read about on this page is backed by the claims-paying ability of the issuing insurer, and why the insurer's financial strength rating matters as much as the rate.
Protect savings
Fixed and fixed indexed annuities do not lose value when the market falls.
Grow tax-deferred
Interest is not taxed each year. You pay tax when money comes out.
Create lifetime income
Turn a lump sum into payments that last as long as you do.
Leave money behind
A named beneficiary receives what is left, usually without probate.
The types of annuities, in one screen.
Annuities sort by two questions: how the money grows, and when the income starts. These are the four you will hear about most.
Fixed annuity & MYGA
The insurer declares an interest rate. A multi-year guaranteed annuity (MYGA) locks that rate for the whole term, often 3 to 10 years.
- ✓Rate known on day one
- ✓No market exposure
- ✓Often compared with CDs
Fixed indexed annuity
Interest is credited based on how a market index performs, up to a cap, with a 0% floor in years the index falls.
- ✓More growth potential than fixed
- ✓No credited losses from index drops
- ✓Optional lifetime income riders
Income annuity (SPIA / DIA)
Trade a lump sum for guaranteed payments that start right away (immediate) or on a date you choose (deferred).
- ✓Closest thing to a pension
- ✓Payments can last for life
- ✓Covers an income gap
Variable annuity & RILA
Your money is invested in market subaccounts, so the value can go down. These are securities: they need a securities license and come with a prospectus.
- ✓Market risk to principal
- ✓Higher ongoing fees
- ✓Sold by securities-licensed reps
Not sure which type you are looking at? The contract will say. So will the first page of any illustration.
How annuities work, step by step.
Every annuity, however it is marketed, follows the same four steps. The type you choose changes what happens in step two.
A lump sum or a series of payments.
Money can come from savings (non-qualified) or from an IRA or old 401(k) rolled over (qualified). Where the money comes from decides how it is taxed later.
At a declared rate, an index-linked rate, or not at all.
A fixed annuity earns a declared rate. A fixed indexed annuity earns interest tied to an index. An immediate annuity skips this step and starts paying.
Withdrawals, lifetime income, or a lump sum.
Most contracts allow a free withdrawal each year. You can also annuitize (convert the value into guaranteed payments) or add an income rider.
To the beneficiary you name.
In the accumulation phase, beneficiaries typically receive the account value. A named beneficiary usually avoids probate. Heirs pay income tax on the gain.
Annuity pros and cons, honestly.
An annuity solves specific problems and charges for it in flexibility. Anyone who shows you only the left column is selling, not explaining.
What annuities do well
- ✓Income you cannot outlive, if you choose a lifetime payout or income rider
- ✓Fixed and fixed indexed annuities do not lose value when the market falls
- ✓Growth is tax-deferred until you take it out
- ✓No IRS cap on how much non-qualified money you can put in (insurers set their own maximums)
- ✓A named beneficiary usually receives the money without probate
What they cost you
- !Surrender charges if you take out more than the free amount in the first several years
- !Gains are taxed as ordinary income, not at capital gains rates
- !A 10% IRS additional tax on taxable withdrawals before age 59½, with some exceptions
- !No step-up in basis: heirs pay income tax on the growth
- !Fixed payments lose buying power to inflation unless you choose an increase option
- !Optional riders cost extra, and every guarantee depends on the insurer
Is an annuity right for your retirement?
Annuities are a retirement-income tool, not a place for money you might need next year. These are the patterns we see when one fits, and when it does not.
An annuity often fits when…
You are within about ten years of retirement, or already there, and the questions have shifted from growing money to making it last.
- ✓Your essential bills are more than Social Security plus any pension will cover
- ✓You have savings you will not need to touch for the surrender period
- ✓Market drops cost you sleep, or a bad first few years would derail your plan
- ✓You have already used your 401(k) and IRA limits and want more tax deferral
It usually does not fit when…
The money has a job in the next few years, or the annuity would hold most of what you own.
- ✓You do not yet have an emergency fund outside the annuity
- ✓You are carrying high-interest debt
- ✓It would hold nearly all of your savings in one contract
- ✓Someone wants you to cash in an existing annuity early: check the surrender charges first
The Retirement Flight Plan includes a 60-second Income Gap Check. It is the fastest way to see which column you are in.
Annuity vs 401(k): not really a contest.
A 401(k) is an account your employer sponsors. An annuity is a contract with an insurer. They do different jobs, and plenty of retirees use both: the 401(k) to save while working, an annuity to turn part of those savings into protection or income later.
While you are working, an employer match is usually the first money worth capturing, and an annuity does not replace it. At or near retirement, many people roll part of a 401(k) into an IRA and use an annuity inside that IRA for a guarantee they cannot get from a fund. One thing to know: inside an IRA, an annuity's tax deferral adds nothing, because the IRA is already tax-deferred. The reason to use one there is the guarantee. We cover the rollover rules on how annuities are taxed.
Planning the whole retirement, not just one product? Retirement Decoded is our free guide and workbook on the five decisions that decide whether retirement income lasts.
Quick answers.
What is an annuity?
An annuity is a contract with an insurance company. You pay the insurer a lump sum or a series of payments, and in return it either grows your money on the terms in the contract or pays it back to you as income, for a set period or for life. Guarantees are backed by the claims-paying ability of the issuing insurer.
How do annuities work?
You fund the contract, it grows during the accumulation phase (at a fixed rate, an index-linked rate, or not at all for an immediate annuity), and then you take money out as withdrawals, lifetime income or a lump sum. Whatever is left when you die goes to the beneficiary you name. Growth is tax-deferred until it comes out.
Are annuities a good idea for retirement?
They can be, for a specific job: covering the gap between your essential expenses and your guaranteed income from Social Security and any pension, or protecting part of your savings from market losses. They are a poor fit for money you may need in the next few years, because of surrender charges, or as a home for nearly all of your savings.
Is an annuity an investment?
No. Fixed, fixed indexed and income annuities are insurance contracts, regulated by state insurance departments. They are used for protection, tax deferral and guaranteed income rather than market growth. Variable annuities and RILAs are different: they are securities, and their value can fall with the market.
Can I lose money in an annuity?
A fixed or fixed indexed annuity does not lose value because the market falls. You can still lose money by surrendering early (surrender charges and, on some contracts, a market value adjustment), through optional rider fees, or if the insurer itself fails, which is why its financial strength matters. Variable annuities can lose value with the market.
What happens to my annuity when I die?
During the accumulation phase, your beneficiary typically receives the account value, usually without surrender charges and without going through probate. If you had already started lifetime income, what happens depends on the payout option you chose: a life-only payout stops, while period-certain and refund options keep paying a beneficiary. Heirs owe income tax on any gain.
What fees do annuities have?
Many fixed and fixed indexed annuities have no annual management fee in the base contract. The costs show up elsewhere: surrender charges for early withdrawals, annual charges for optional riders such as income riders, and in fixed indexed annuities the caps and participation rates that limit your share of index gains. Variable annuities typically carry ongoing fees.
Do you sell variable annuities?
No. Variable annuities and registered index-linked annuities (RILAs) are securities and require a securities license. We work with fixed, fixed indexed and income annuities. If a variable product genuinely suits you better, we will say so and point you to a securities-licensed professional.
Find out whether you have an income gap.
Bring your Social Security estimate and a rough monthly budget. In thirty minutes you will know whether an annuity has a job to do in your plan, and if it does not, we will tell you that too.
Not ready to talk? Get the free Retirement Flight Plan: 7 mistakes that ruin the landing.
Important: Annuities are insurance contracts, not bank deposits. They are not FDIC insured and are not guaranteed by any bank or government agency. Guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company. Withdrawals above a contract's free amount during the surrender period may be subject to surrender charges and, on some contracts, a market value adjustment. Taxable amounts withdrawn before age 59½ may also be subject to a 10% IRS additional tax. Fixed indexed annuities are not a direct investment in the stock market or in any index. Products, features and availability vary by carrier and by state. iCoach Solutions offers fixed, fixed indexed and income annuities. We do not offer securities, including variable annuities, and we do not give investment, tax or legal advice: talk with a qualified tax professional about your own situation. This page is general education, not a recommendation.