Introduction
You've spent decades building a nest egg. Now comes the harder part: turning it into income that lasts as long as you do, without taking on more market risk than you can stomach.
About one in three 65-year-olds will live to at least 90, according to Social Security Administration data. That's a long stretch to fund.
An annuity is one tool for the job. It's an insurance contract funded with a lump sum or a series of premiums, in exchange for future payments. This guide covers how annuities work, their real advantages, their limits, the main types, and how to decide whether one fits your plan.
Key Takeaways
- An annuity can turn part of your savings into income for a set period or for life.
- Its main advantage is protection against outliving your money.
- Fixed, variable, indexed, immediate, and deferred contracts carry very different risks and costs.
- Liquidity, surrender charges, taxes, inflation, fees, and insurer strength all need review before you buy.
How Do Annuities Work?
What is an annuity?
An annuity is a contract with an insurance company. It isn't a bank account or a retirement plan. Any guarantee depends on the contract's terms and the insurer's claims-paying ability.
The three phases of an annuity
- Purchase: You fund the contract with one premium or several over time.
- Accumulation: The value may earn interest or follow selected investments, depending on the type.
- Income: Payments begin, either immediately or later. Options include lifetime payments, period-certain payments, and joint-life payments.
Immediate annuities generally start paying within one year. A lifetime-withdrawal rider is a separate mechanism from annuitization, so don't confuse the two.
What determines the payments?
Payout amounts depend on:
- Premium size
- Your age and sex
- Mortality assumptions and interest rates
- Income start date and duration
- Single-life or joint-life terms
- Optional riders
Several dollar figures in one contract can differ, and the differences matter:
| Figure | What it means |
|---|---|
| Account value | Value during accumulation, after credits, withdrawals, and charges |
| Cash surrender value | What you'd receive by terminating, after surrender charges |
| Income benefit base | A calculation amount for an income guarantee, not cash you can withdraw |
| Death benefit | What beneficiaries receive under the contract |
Types of Annuities and How They Differ
Immediate and deferred describe timing. Fixed, variable, and index-linked describe how value is credited. They are two dimensions, not six separate categories.
Immediate versus deferred annuities
An immediate annuity is usually funded with a single premium and starts paying within a year. It suits someone who needs income now. A deferred annuity lets value build first, which fits someone planning income years ahead.
Fixed annuities
A fixed annuity credits interest set by the insurer, with a contractual minimum. Before you buy, confirm:
- The gap between the contractual minimum and the current credited rate
- Renewal terms after the initial guarantee period
- Surrender periods and withdrawal provisions
Variable, fixed-index, and registered index-linked annuities
- Variable: Value follows the investments you pick. Losses are possible, and optional guarantees carry their own costs.
- Fixed-index: Interest is tied to an index formula, limited by caps, participation rates, or spreads. A 0% floor doesn't stop charges from reducing value.
- Registered index-linked (RILA): An SEC-registered security with gains and losses tied to an index, within stated limits.
On a RILA, a buffer absorbs an initial loss, and a floor caps the loss you can take. The SEC's example: a 12% index decline with a 10% buffer produces a 2% loss, while a 10% loss floor produces a 10% loss, before other adjustments.
Advantages of Annuities
Lifetime income and longevity protection
A lifetime payout option addresses the risk of outliving your savings. It can supplement Social Security, a pension, or portfolio withdrawals.
Social Security replaces only part of most retirees' income, roughly 31% on average for people over 65.
Predictable cash flow
Dependable payments make essential expenses easier to budget. They may also reduce the need to sell investments in a down market. A payment guarantee is not guaranteed investment growth, though.
Morningstar's 2025 modeling shows the trade-off. A $100,000 immediate-annuity allocation with 3% annual payment increases raised lifetime spending by about $30,000 but cut median ending assets by roughly $230,000, per Morningstar's analysis. That's a modeled 30-year outcome, not a promise.
Tax-deferred accumulation
With a non-qualified annuity (bought with after-tax money), earnings grow tax-deferred until distribution, then are taxed as ordinary income. An annuity held inside an IRA or 401(k) adds no extra tax deferral. Evaluate its insurance features on their own merits.
Portfolio diversification and risk management
An annuity can cover essential spending so other assets stay invested for growth, liquidity, or legacy goals. Market protection varies a lot by product.
Customizable income and legacy features
- Single-life or joint-life payouts
- Period-certain guarantees
- Fixed or CPI-linked increases
- Enhanced death benefits
- Long-term-care-related benefits on some variable annuities
Each option typically lowers starting income or adds a fee. A CPI adjustment, for example, means a smaller first payment.
Potential Drawbacks and Risks to Consider
Liquidity limits and surrender charges
Annuities are long-term contracts, and surrender charges generally decline over a set period. FINRA notes variable-annuity periods can run eight years or more. Many contracts allow limited free withdrawals, but annuitizing usually means you can't cash out later. Keep emergency savings elsewhere.
Withdrawals before 59½ may also trigger an additional 10% federal tax on taxable amounts, with a few exceptions.
Fees, commissions, and contract complexity
Variable annuities can stack several layers of cost:
- Mortality and expense charges, as a percentage of account value
- Administrative charges, flat or percentage-based
- Underlying fund expenses
- Rider charges
- Surrender charges
Comparing just one fee understates the total cost, and insurance products also pay commissions. Read the prospectus and contract for current charges rather than relying on averages.
Inflation, growth, insurer, and legacy risks
- Inflation: Consumer prices rose 34.1% from 2016 to 2025, meaning a level payment lost about 25.5% of its purchasing power, based on BLS data.
- Market risk: Higher-growth options can lose principal when markets decline.
- Insurer risk: Guarantees rest on the insurer's financial strength. State guaranty associations typically cover about $250,000 in present value, with exclusions.
- Legacy: Lifetime income may leave less for heirs if you die early. Period-certain and beneficiary features can soften this, usually at the cost of lower income.
Is an Annuity Right for You?
Start with the retirement income gap
- Total your essential expenses: housing, food, health care, insurance, taxes.
- Subtract dependable income: Social Security, pensions, other guaranteed payments.
- The remainder is your gap. If there isn't one, you may not need an annuity.
Match the contract to the goal
- Income now: an immediate annuity
- Income later: a deferred or deferred-income annuity
- Principal protection: a fixed annuity
- Market participation: variable, indexed, or RILA, with eyes open on risk
- Legacy: death benefit or period-certain options
Review personal circumstances
Weigh factors such as:
- Age and health
- Marital status
- Liquidity needs and emergency reserves
- Tax bracket
- Existing retirement accounts
- Whether the money may be needed for other goals
Use a contract-review checklist
Ask about:
- The insurer's financial strength ratings
- Guarantees versus current assumptions
- Surrender schedule and withdrawal rules
- All fees, including riders
- Inflation adjustments and beneficiary terms
- Tax consequences and income start date
- What happens if you exchange or terminate
Most states offer a free-look period, commonly 10 to 30 days.
Be careful with exchanges. A qualifying 1035 exchange can avoid immediate taxable gain, but it doesn't erase surrender costs. IRS Revenue Ruling 2007-24 notes that receiving a check and forwarding it doesn't qualify.
How a fiduciary advisor can help
Lewis & Associates Capital Advisors, LLC is a North Carolina registered investment adviser serving clients from Holly Springs and Raleigh. The firm reviews a client's entire portfolio to see whether an annuity fits, and doesn't assume one does.
Its fiduciary duty applies to investment advisory advice, not to insurance or broker-dealer services. No strategy is assured to reach its goals.
Before committing funds, compare an annuity with managed investments, bonds, cash reserves, and Social Security claiming strategies.
Frequently Asked Questions
How much will a $100,000 annuity pay out per month?
It depends on age, sex, interest rates, annuity type, start date, joint or single life, and guarantee period. As an example only, single-life immediate annuity surveys showed about $586 per month for a 60-year-old man and $643 at 65. This is not a quote.
What are the fees associated with a variable annuity?
Expect administrative fees, mortality and expense charges, underlying fund expenses, surrender charges, and optional rider costs. Check the prospectus and contract for current figures.
How do you value an annuity?
Present value discounts expected future payments, weighted by survival odds. That differs from account value, cash surrender value, and income benefit base. Payment amount, timing, discount rate, and contract terms all matter.
Is it worth having a retirement annuity?
It may be when guaranteed income is needed for essential expenses. The answer depends on liquidity needs, fees, taxes, inflation, alternatives, and the specific contract.
Is it a good idea to buy an annuity at age 60?
Age alone doesn't decide it. Consider retirement timing, income needs, health, spouse goals, access to cash, taxes, and whether income should start now or later. Later purchases pay more monthly but forgo earlier payments.
