What is an annuity?
An annuity is issued by an insurance company. A person may pay one premium or a series of premiums. Depending on the contract, money may accumulate first, income may begin soon, or income may begin at a chosen future date.
The word annuity describes a broad family of contracts. A fixed deferred annuity used to accumulate money does not work the same way as an immediate income annuity used to create monthly payments. Before comparing features, identify the purpose of the contract.
Accumulation purpose
The contract value earns interest or changes according to the contract rules. The owner usually has some withdrawal access, subject to limits and possible charges.
Income purpose
A premium or accumulated value is converted into payments for a selected period, for life, or for two lives, depending on the payout option.
The two phases
1. Accumulation phase
During accumulation, the contract builds value. In a fixed annuity, the insurer declares how interest will be credited, subject to the minimums and periods described in the contract. Earnings in a nonqualified annuity generally grow tax-deferred until distributed.
2. Income or distribution phase
Later, the owner may take withdrawals, surrender the contract, or choose an income option if the contract allows it. Annuitization is the formal conversion of value into a series of payments. It can be difficult or impossible to reverse, so the payout option deserves careful review.
The main types in plain language
| Type | How value or income is determined | Primary question |
|---|---|---|
| Fixed deferred annuity | Interest is credited under rates and minimums stated by the insurer and contract. | How long is the current rate guaranteed, and what happens after that period? |
| Fixed income annuity | The contract states an income payment based on the premium, age, start date, payout option, and insurer pricing. | What payment continues, for whom, and what access or beneficiary value remains? |
| Fixed indexed annuity | Interest may be linked in part to an external index through caps, participation rates, spreads, or other contract rules, with stated minimums. | Which parts can change, and how is index-linked interest calculated? |
| Variable annuity | Value and payments may change with selected investment subaccounts; additional insurance features may apply. | What market risk, fees, and insurance guarantees apply? |
This website concentrates on fixed accumulation and fixed lifetime income. Variable and registered annuities involve securities considerations beyond this site's core scope.
What is actually guaranteed?
Different annuity contracts guarantee different things. A fixed deferred annuity generally guarantees at least a minimum interest rate. A multi-year fixed contract may state a higher rate for a specific period. A fixed income annuity guarantees the payment described in the contract. Other values, renewal rates, withdrawals, bonuses, or optional benefits may have separate conditions.
Five parts of a guarantee
- What: a rate, account value, income payment, death benefit, or withdrawal feature.
- How much: the exact percentage, dollar amount, formula, or minimum.
- How long: a stated term, a lifetime, or another defined period.
- Under what conditions: holding the contract, avoiding excess withdrawals, paying for a rider, or choosing a payout option.
- Who stands behind it: the issuing insurance company, subject to its claims-paying ability.
An annuity is not a bank deposit and is not insured by the Federal Deposit Insurance Corporation. State insurance regulation and guaranty association protections differ from federal deposit insurance and should not be used as the main reason to purchase a contract.
Tax deferral is not tax elimination
For a nonqualified annuity purchased with after-tax money, earnings generally are not taxed while they remain in the contract. Tax is typically due when taxable earnings are distributed. The tax treatment of withdrawals and income payments can differ, and an additional federal tax may apply to some distributions before age 59 1/2.
An annuity held inside an IRA or another tax-deferred retirement account does not create an extra layer of tax deferral. Tax rules are individual and can change, so a tax professional should review the specific situation.
Access, charges, and contract adjustments
Fixed annuities can offer predictable contract values, but predictable does not mean fully liquid. Review all ways that taking money out may affect value.
- Surrender charge
- A charge that may apply when more than the permitted amount is withdrawn during a stated period. The charge often declines over time.
- Free-withdrawal provision
- A contract feature that may permit a limited amount to be withdrawn without a surrender charge. Taxes and other adjustments can still apply.
- Market value adjustment
- A formula that may increase or decrease a withdrawal or surrender amount based in part on changes in interest rates or another reference. Read the exact contract formula.
- Rider charge
- A fee for an optional benefit, such as a living-benefit or enhanced death-benefit feature. Not every fixed annuity has riders or rider fees.
- Annuitization
- The conversion of value into periodic payments. The decision and payout option may be irrevocable.
Seven questions before looking at a rate
- What retirement goal is this contract intended to address?
- Which benefit is guaranteed, and for exactly how long?
- What access is available each year, and what can reduce the amount received?
- What rate or payment can change, when can it change, and what is the guaranteed minimum?
- What happens at death, at the end of the guarantee term, or if long-term care is needed?
- Is an existing annuity or life insurance contract being replaced, and what benefits or surrender values would be lost?
- Which licensed professional can explain the insurance, tax, estate, and broader planning consequences?
Core terms
- Annuitant
- The person whose life may be used to determine an income benefit. The annuitant, owner, and beneficiary can be different people.
- Beneficiary
- The person or entity named to receive a contract benefit after the owner's or annuitant's death, subject to the contract.
- Claims-paying ability
- The issuing insurer's financial capacity to meet its obligations. Ratings are opinions, can change, and should be reviewed from more than one source.
- Current rate
- The rate the insurer is presently crediting. It may be guaranteed for a stated period or subject to change under contract rules.
- Guaranteed minimum rate
- The lowest interest rate the contract promises under its terms. It may be lower than a current or promotional rate.
- Premium
- The money paid into an annuity contract.
- Surrender value
- The amount available if a contract is ended, after applicable charges, adjustments, withdrawals, and other contract provisions.
Public sources used for this guide
Investor.gov: Annuities (opens in a new tab)
Overview of annuity contracts, deferred annuity types, fixed guarantees, and investor questions.
FINRA: Annuities (opens in a new tab)
Consumer information about fixed, variable, and indexed annuities, contract features, costs, and restrictions.
NAIC Buyer's Guide to Fixed Deferred Annuities (opens in a new tab)
A detailed consumer guide to fixed deferred annuity rates, charges, withdrawals, and questions.