AARP Hearing Center
7 Key Things to Know About Annuities
Whether you’re looking for steady retirement income or a low-risk investment, check the fees and the fine print
Video: How Annuities Can Be A Secret Gen X Retirement Hack
Key takeaways
- Annuities are insurance products that can provide guaranteed income in retirement.
- Annuities vary widely in type, payouts, fees and investment risk.
- Their complexity and limited liquidity make careful review and planning essential.
Annuities are having a moment. Sales of these products have more than doubled over the past five years, from $219 billion in 2020 to $464 billion in 2025, according to LIMRA, an insurance and financial services trade association.
The allure is apparent. Annuities offer a way to get a guaranteed stream of income in retirement at a time when relatively few private-sector workers have access to a pension plan.
More Ways to Benefit
- Related Benefit 1
- Related Benefit 2
- Related Benefit 3
- Related Benefit 4
- Related Benefit 5
“A higher level of guaranteed income is typically associated with less worry and more fulfillment in retirement,” says Jeff Judge, managing partner at Chesapeake Financial Planners in Forest Hill, Maryland. “If your needs are covered by guaranteed income, you’re not worried about running out of money.”
Still, annuities are complex products — which might explain why there’s so much confusion about them. In a 2024 survey by insurance marketplace Policygenius, only 1 in 4 adults 55 and older could identify the correct definition of an annuity. Survey respondents often mistook annuities for other products, such as individual retirement accounts (IRAs), 401(k)s and life insurance.
Judge says it’s not uncommon for new clients to arrive with annuities in their portfolio that they don’t fully understand. “They’re not sure what they have or how they work,” he says.
Given their complexity and growing popularity, taking the time to understand annuities is more important than ever. Here are seven things you should know if you’re thinking about making an annuity part of your retirement plan.
Annuities are insurance products
An annuity is a contract with an insurance company. In the simplest case, for a lump sum payment, an insurance company will provide you with a predictable stream of payments for a certain number of years or for the rest of your life.
Annuities can also provide peace of mind by offering a guaranteed rate of return on your money. Some types of annuities that are tied to stock market indexes can even protect against market losses (more on that below). “Because you sign a contract with the issuing company, they are able to offer these guarantees that you normally cannot receive through a standard investment account,” says Zachary Bachner, director of financial planning at Summit Financial Consulting in Sterling Heights, Michigan.
Annuities come in several types
Annuities can serve different goals and have varying levels of risk, depending on the type that’s purchased.
Income annuities come in two options:
- Single premium immediate annuities (SPIAs) are purchased with a single payment, then “annuitized” within 30 days to a year to generate regular payments that last for a lifetime or a certain number of years. Lifetime payout amounts are based on age, sex and the interest rate, with women receiving lower payouts because they have longer life expectancies, says Bryan Hodgens, senior vice president and head of research for LIMRA. Payouts made for a fixed period aren’t affected by the age and sex of the annuity owner.[[
- Deferred income annuities (DIAs) are similar to SPIAs, but the payouts begin at a future date that you choose — typically five to 20 years after the annuity is purchased — rather than immediately. The benefit of waiting is that the payouts are higher. The risk is that the annuity owner could die before payouts begin. A death benefit can be added for an extra cost to guarantee beneficiaries receive at least the amount originally invested in the annuity.
Fixed annuities are similar to certificates of deposit, Hodgens says. You pay a lump sum or series of payments, and the insurer pays a guaranteed rate of return on the money you invest for a specified period of time — for instance, three, five, seven or 10 years. Rates on fixed annuities are typically higher than CD and money market rates, Judge says, but lower than investments such as stocks and mutual funds, and they might not keep up with the pace of inflation.
Fixed index annuities are tied to the performance of a market index such as the S&P 500, meaning they have the potential to earn a higher rate of return than fixed annuities. Fixed index annuities have a cap rate or participation rate that limits their returns. For example, if the cap rate is 8 percent and the S&P 500 rises 10 percent over the next 12 months, the annuity value will increase by only 8 percent, Hodgens says. On the bright side, fixed index annuities don’t experience any of the losses of the index to which they’re tied.
Variable annuities come with more risk but the potential for a higher return, Hodgens says. They allow you to invest your money in mutual fund-like accounts with stocks or bonds. The value of the account will rise and fall with the performance of the underlying investments. Unlike fixed index annuities, there is no downside protection with variable annuities.
Registered index-linked annuities (RILAs) are a hybrid of fixed index and variable annuities. “You get a certain amount of upside growth and certain downside protection,” Hodgens says. RILAs track the performance of a market index and usually have a higher cap rate on the returns than fixed index annuities do. However, if the index declines, you’re only protected up to a certain percentage of that decline.
Annuities offer a variety of payout options
The type of payout you choose affects the amount you receive and whether your heirs will continue to receive payments after your death. You need to understand how the various payout options work because you can’t make changes once an option is chosen and payouts begin.
Life only allows you to receive payments as long as you are alive. Once you die, the payments stop, and any remaining balance in the account does not pass on to your heirs.
Period certain only lets you receive payments for a set number of years, such as 10 or 20. Payouts are usually higher than in the life-only option. And if you die within the predetermined period, your beneficiaries receive payments for the remainder of the period. However, you could outlive the payment period, leaving you without that source of income.
Life with period certain allows you to get payments for life and provides payments to beneficiaries if you die within a certain period. Payout amounts are lower than those in life-only contracts because of the death benefit for heirs.
Joint and survivor allows couples to ensure that when one spouse dies, payouts continue for the surviving spouse. This option typically has the lowest payout.
Annuity payouts have special tax rules
Annuities are often promoted for their tax-deferred growth, says David Haas, owner of Cereus Financial Advisors in Franklin Lakes, New Jersey, meaning you don’t pay taxes on investment earnings until you withdraw the money. This benefit also is true of 401(k)s and IRAs.
Payouts from an annuity are subject to ordinary income taxes, with the tax bite dependent on several factors. If you bought the annuity with money inside a traditional IRA or 401(k) — this is what’s known as a “qualified” annuity — your full payout would be taxed as ordinary income, just like any other distribution from retirement accounts, since contributions to those accounts are made with pretax or tax-deductible dollars.
If, however, you bought an annuity with money that wasn’t in those traditional retirement accounts — that would be a “nonqualified” annuity — the situation would be different. You wouldn’t be taxed on the portion of the payout coming from the principal you used to buy the annuity, but the portion of the payout representing earnings would be taxed as ordinary income. (The IRS has rules that determine how these portions are calculated.) The tax treatment of annuities bought outside of retirement accounts can put them at a disadvantage compared to long-term investments in a regular investment account, says Haas. Depending on your earnings, taxes on ordinary income can currently be as high as 37 percent. On the other hand, taxes on capital gains and dividends from securities held long enough in a brokerage account max out at 20 percent and are lower than ordinary income tax rates at most income levels.
Annuities have limited liquidity
When you buy an annuity, you trade easy access to your cash for the promise of future payouts. For example, once you make a payment for a SPIA, you can’t get your lump sum back, Haas says.
You will face surrender charges if you pull money out prematurely from annuities such as fixed, fixed index and variable annuities that have an accumulation phase, when money is still being invested and growing. These annuities have what’s called a surrender period, which can range from three to 10 years. The surrender charge is typically 7 percent of the amount withdrawn in the first year of the contract and decreases by a percentage point each year thereafter.
In addition, you have to pay a 10 percent tax penalty on annuity withdrawals before age 59½, as you would with early withdrawals from a 401(k) or IRA.
Annuities are not designed to for short-term liquidity, says Michel Leonard, chief economist at the Insurance Information Institute (III). “They are retirement products that require planning,” he says. “It’s a safety net product.”
Annuities have a variety of fees and charges
In addition to surrender charges, many annuities have a variety of fees, including administrative fees to cover recordkeeping and account services, according to the III. Variable annuities often have the highest fees, to cover costs associated with investment management and additional guarantees for income protection and death benefits. “You wind up with fees that are 3, 4 percent sometimes,” Haas says.
Some fees are embedded in products such as fixed index annuities and RILAs in the form of cap rates on returns, Hodgens says. And there are optional fees for add-ons called riders that provide benefits such as the ability to turn income payments on and off once you annuitize. The fee for riders can range from 0.5 to 1.25 percent of the principal amount you invested in the annuity, he says.
“These fees can very likely hinder the growth or income potential of the product,” Bachner cautions. That’s why it’s important to ask about all fees associated with any annuity you consider buying.
Annuities require due diligence
Before buying an annuity, consider whether it actually fits in your retirement plan. “Many are distributed through commission-based channels,” says Rob Greenman, a certified financial planner with Vistal Capital Partners in Portland, Oregon. “Too often they’re pushed, not chosen, leading investors into expensive, complex products that don’t align with their needs.”
You’ll also want to evaluate the financial strength of the issuing insurer, since your future payments depend on the company’s ability to meet its obligations. You can check insurance company ratings with independent organizations such as A.M. Best, Fitch Ratings and S&P Global.
Consider consulting a financial adviser who can help you assess whether an annuity makes sense for you and if so, what type would be best.
AARP Membership
Join AARP for only $15 per year with automatic renewal. Get instant access to members-only products and hundreds of benefits, a free second membership, and a subscription to AARP The Magazine.
More From AARP
Looking For Reliable Retirement Income?
Annuities can provide steady payments but are often complicated, making research key
What to Know About Investment-Linked Annuities
These popular insurance products can create a lifelong income stream — at a price
Are Workers Warming Up to In-Plan Annuities?
Surveys show growing interest in 401(k) plans that offer a guaranteed-income option