Annuity FAQs

An annuity is a customizable contract between you and an insurance company. You pay a lump sum or series of premiums in exchange for a guaranteed fixed income stream from the insurer.

Payouts from the insurance company can last for a specified time period or the rest of your life. Annuities are often used to guarantee income in retirement, similar to a pension.

Annuities and traditional savings accounts are both considered low-risk investment options that may interest. However, there are many differences. Annuities are backed by the financial strength of the insurer while savings accounts are most often backed by FDIC-insurance. Most annuity contracts are build to offer lifetime income while savings accounts do not. Other differences include fee structure, liquidity and the minimum amount of money required to open an account.

Annuities and retirement accounts — such as 401(k) plans and Individual Retirement Accounts (IRAs) —feature tax-advantaged ways to save for retirement. However, IRAs and 401(k) place your money in investments, while annuities are insurance products that grow money in various ways ranging from guaranteed rates of return to progressively more market-based options.

Annuities also generally have higher fees than retirement accounts, but without any annual IRS-imposed contribution limits.

One of the most attractive features of annuities is creating a guaranteed life-long stream of income. Many people worry about outliving their savings in retirement, and annuities help hedge against this risk.

Another key advantage of annuities is the ability to save money for your future without paying taxes on the growth until later when you withdraw the money.

Unlike retirement accounts, there’s no IRS-imposed limits on annuity contributions.

Certain annuities can be complex due to the types of income and growth guarantees available. Conservative annuity policies such as fixed rate annuities will not grow your money as quickly as other investment options, such as investing directly into the stock market.

Annuities also lack liquidity, which means it’s difficult to quickly access additional money without incurring high fees.

If your financial priorities change, you can sell your future annuity payments back to the insurance company at a discounted rate in exchange for cash. You can sell your entire annuity or just part of it.

If you sell future payments, you will receive less money than if you had continued the original payment schedule specified in your contract.

There are three main types of annuities: Fixed, fixed index and variable.

Fixed annuities are tied to a guaranteed interest rate and are the lowest risk option. They offer fixed, predictable payouts and an explicit guarantee of principal protection from the issuing insurance company.

Fixed Index annuities feature characteristics that provide a balance between the guarantees of fixed annuities and the higher potential growth rate of variable annuities. Growth is linked to a portion of a market index return, such as that of the S&P 500 but without the risk of losing your principal if the market turns negative. This makes index annuities less risky than variable annuities while offering greater earning potential than fixed annuities.

Variable annuities carry greater risk because account growth is tied to an investment portfolio. Growth will vary based on the market performance and any optional riders purchased.

If you want to set aside additional money for retirement, an annuity's tax-free growth can be beneficial. If you’ve already maxed out other retirement savings vehicles, such as a 401(k) or IRA, annuities may be even more appealing due to their lack of contribution limits.

You may also consider purchasing an annuity if your market risk tolerance is low. An annuity is considered a low-risk financial product that can guarantee lifetime income payments.

if moderating your exposure to the market appeals to you, you may want to consider purchasing an annuity.

The terms immediate and deferred indicate when annuity payouts from the insurance company begin.

Payouts from immediate annuities start less than a year after purchase.

Deferred annuities, on the other hand, begin payouts further in the future. Deferred annuities are most commonly used to plan for a retirement date multiple years into the future.

The answer depends on the contract and whether you have annuitized, which means turned the contract into lifetime income. Unannuitized contracts may have surrender charges for withdrawals that exceed 10% of the contract value.

If you withdraw money from an annuity before the age of 59.5, you will face a 10 percent tax penalty from the Internal Revenue Service.

Yes, but how annuities are taxed and how much you’ll owe can vary.

For example, qualified annuities use pre-tax dollars and are often funded using a 401(k) or IRA. Because this money hasn’t been taxed yet, payouts from this annuity type are fully taxable as income.

However, annuities purchased with a Roth IRA or Roth 401(k) usually enjoy tax-free payouts.

Annuities funded with after-tax dollars are considered nonqualified. Money you originally contributed to the account is not taxed, but any earnings or interest is taxed at your regular income rate.

Withdrawing money early in your annuity contract can result in surrender charges.

Many insurers levy this fee if you take money from your account within the first five to seven years. The average surrender charge is around 7 percent but may be as high as 20 percent.

Surrender charges tend to decrease each year. So, taking money from your annuity after a year will have a higher surrender fee than taking money out after five years.

Some annuities let you withdraw up to 10 percent a year from your account without paying a surrender fee.

Possibly. Fixed annuities guarantee the safety of your principal, or the money given to the insurer to fund your annuity.

Fixed index annuities offer protection against losses that safeguards your investment value when the market is down. Such guarantees typically reset after a certain period of time to incorporate some of the credit growth.

According to the U.S. Securities and Exchange Commission, it’s possible to lose money in a variable annuity, including potential loss of your original investment, or principal.

That’s because the value of a variable annuity and its returns are linked to investment options you select. If those investments do poorly, you can lose money.

You select how much money to place in your annuity. Depending on the type of annuity you choose, this can be as little as $10,000 or as much as $1 million or more.

However, the cost of annuity fees and commissions can vary. Typically, more complex financial products come with the potential for higher fees from optional features and riders.

For example, fixed annuities have lower costs than variable or indexed annuities. That’s because fixed annuities pay at a predictable rate and aren’t tied to investment portfolios or market indexes.

It depends on how you structured your annuity contract with the insurance company.

With some annuities, payments end when you die.

But if the annuity contract has a death benefit provision, the insurer will continue making payments to your spouse or other designated beneficiary.

If your annuity contract includes a death benefit, your selected beneficiary will either receive all the remaining funds or a guaranteed minimum amount.

There are a few different ways nonspousal beneficiaries can receive the money after you pass away. This includes taking a one-time lump sum, stretching payments over the beneficiary's lifetime or taking payments over five years.

Spouses may also have the option to continue the original contract as the annuity’s new owner.

You will owe income tax on the difference between the principal paid into the annuity and the value of the account when the owner dies. Taxes are not owed until money is withdrawn from the account.

Beneficiaries can lessen their tax burden by spreading payments over a longer period. Taking a lump sum comes with the highest tax consequences.