Educational overview
Annuities
Annuities have a reputation problem. This page is not here to defend them or sell them — just to explain plainly what one is and why people use them.
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Plain English
What is an annuity?
An annuity is a contract issued by an insurance company. Depending on the type, it may be designed for accumulation, for income, or for both.
Because it is a contract rather than an account, the features, limitations and any guarantees come from the contract terms and the claims-paying ability of the issuing insurer. Annuities are not appropriate for everyone.
Why people use them
Four common reasons.
Depending on product type, some annuities are designed to limit exposure to market loss.
Growth inside the contract is generally not taxed until it is withdrawn, under current tax rules.
Certain contracts offer income options intended to pay on a set schedule.
Some options are designed to continue paying for life, subject to contract terms.
Main types
Three broad categories.
The insurer credits a stated rate of interest for a stated period. Predictable, and generally the simplest to understand.
Interest credits are linked in part to an external market index, with limits on both upside and downside as defined in the contract.
Value is tied to underlying investment options and can decline. These are securities and involve investment risk.
Plain language, finally
Three ways money can grow.
Annuities are like weather forecasts — fixed is a clear day, variable is a coin flip, index is bringing an umbrella just in case.
Annuities can be built around any of these three. Which one — if any — makes sense is a Finn conversation.
Two jobs
Accumulation vs income.
Accumulation phase
- Money is contributed and left to grow
- Growth is generally tax-deferred under current rules
- Withdrawal limits and surrender charges usually apply
- Measured by contract value
Income phase
- The contract begins paying out
- Payments may be for a set period or for life, per contract terms
- The trade-off is usually flexibility for predictability
- Measured by the payment amount
How indexed interest works
Linked to an index — not invested in it.
With an indexed annuity, the owner is not directly invested in the index or in the stock market. The insurer calculates interest credits using a crediting method defined in the contract.
A maximum rate that may be credited during a period.
The percentage of index movement used in the calculation.
An amount subtracted from index gains before interest is credited.
A minimum credited rate for the indexed account, often 0%, subject to contract terms.
Caps, participation rates and spreads can change over time within the limits the contract allows. Those terms matter as much as the index itself.
Liquidity
Access is limited by design.
Most annuities include a surrender period — a set number of years during which withdrawing more than an allowed amount can trigger a surrender charge that reduces the value returned.
Many contracts allow a limited free withdrawal each year. Withdrawals may also be taxable, and withdrawals before age 59½ may carry an additional tax penalty depending on circumstances. An annuity is generally intended as a long-term contract, not an emergency fund.
Common misconceptions
Four things people often assume.
With fixed and fixed indexed annuities, it is not. Interest crediting is calculated by the insurer under contract terms.
Fixed, fixed indexed and variable contracts behave very differently and carry different risks.
Surrender periods, withdrawal limits, caps, spreads and fees all apply depending on the contract.
Any guarantee is defined by the contract and backed by the issuing insurer, not by market performance.
Who may want to learn more
Neutral criteria, not a recommendation.
People often explore annuities when they are approaching or in retirement, already have other retirement savings in place, are concerned about outliving their money, want a portion of income to be more predictable, or have money they do not expect to need in the near term. None of these mean an annuity is appropriate — they are simply the situations in which the question tends to come up.
Questions to ask before buying an annuity
- What type of annuity is this, and how exactly does it credit interest?
- How long is the surrender period, and what happens if I need the money sooner?
- How much can I withdraw each year without a charge?
- What are all the fees, riders and ongoing costs?
- Which features are guaranteed by the contract, and which are not?
- Can the cap, participation rate or spread change after I buy it?
- How will withdrawals be taxed in my situation?
- What happens to this contract when I die?
Educational information only. Annuity guarantees are subject to the claims-paying ability of the issuing insurance company. Variable annuities involve investment risk, including possible loss of principal. Product availability and features vary by state.
Your next step
Explore Retirement Income Options
Nine short questions to see how income, protection and savings fit together before any product conversation.