The central tradeoff is simple. An annuity can reduce longevity or market risk, but you pay for that protection with fees, contract restrictions, reduced liquidity, limited upside, and added complexity.
Longevity is the reason the question matters. The SSA's actuarial life table shows a 65-year-old man can expect about 18 more years and a woman about 21. Many will live far longer.
This guide explains how annuities work, weighs their benefits and drawbacks, and shows how to evaluate one inside a broader retirement-income plan.
Key Takeaways
- Annuities are insurance contracts that turn savings into income for a set period or for life.
- Their main value is dependable income, not the highest return.
- Review fees, surrender charges, taxes, inflation, and insurer strength before buying.
- Fit depends on the gap between essential expenses and your other reliable income.
How Annuities Work
What is an annuity?
An annuity is a contract with an insurance company. You contribute money, and the insurer promises specified benefits, such as growth, withdrawals, or recurring income payments.
Most contracts have two phases:
- Accumulation: your money grows or earns credited interest.
- Distribution: the value converts to income (annuitization), which is generally irrevocable.
Keep one distinction in mind: the account value is not the same as the contractual income benefit. The two can differ substantially.
Immediate versus deferred annuities
Immediate annuities begin paying within a year of a lump-sum purchase. Deferred annuities postpone income or withdrawals until a later date, and can be funded with one payment or several.
Payout options shape income, flexibility, and what heirs receive:
- Single-life: income for life, nothing after death.
- Joint-and-survivor: payments continue until the last covered person dies.
- Period-certain: a set number of years, with remaining payments going to beneficiaries.
- Life plus period-certain: lifetime income plus a guaranteed beneficiary period.
- Refund: beneficiary payments continue until total benefits equal premiums paid.
- Inflation-adjusted: payments rise with CPI but start lower than level payments.
Common types and their risk profiles
- Fixed: guarantees a minimum credited interest rate.
- Fixed indexed: credits depend on an index, limited by caps, participation rates, or spreads. When the index falls, no interest is credited (NAIC's buyer's guide); surrender charges can still reduce principal.
- Variable: value follows underlying subaccounts, so losses can include your original principal.
Guarantees apply only as written in the contract and depend on the issuing insurer's claims-paying ability. They do not make every annuity account immune to market losses.
The Benefits of Annuities in Retirement
Guaranteed lifetime income
A lifetime income annuity addresses longevity risk by paying for as long as you live. Pooling helps: money from people who die earlier funds income for those who live longer.
That makes it a natural match for essential costs like housing, healthcare, and daily living. Payment size, survivor benefits, inflation adjustments, and refund provisions all depend on the contract.
In one Morningstar illustration, a 67-year-old woman buying a $100,000 immediate annuity in October 2025 would receive about $7,700 a year for life. That is a dated example, not a current quote.
Market-volatility management
Fixed and income annuities can make part of your cash flow less dependent on stock performance. That may reduce the need to sell volatile assets during a downturn.
The math of withdrawals in a falling market is harsh. In one example from Lewis & Associates, a 30% market decline combined with 6% annual withdrawals leaves a portfolio needing a 56.25% gain to get back to $100,000.
Variable annuities don't offer this shelter, since their investments can lose value. Indexed annuities limit both losses and gains through caps, spreads, and floors.
Tax-deferred growth
Earnings in a nonqualified annuity grow tax-deferred until distributed. Taxable amounts are ordinary income, and withdrawals before annuitization generally pull out earnings before tax-free cost basis.
Annuitized payments use an exclusion ratio that splits each payment into tax-free and taxable parts, per IRS Publication 939.
Withdrawals before age 59½ generally face an additional 10% tax on the taxable portion, with limited exceptions.
An annuity held inside an IRA or 401(k) adds no extra tax deferral. In that case, the insurance features alone must justify the cost.
Flexibility and customization
Contracts can add features such as:
- Joint-life income
- Death benefits
- Period-certain guarantees
- Inflation adjustments
- Guaranteed lifetime withdrawal riders
Riders usually add fees and limits.
You don't have to annuitize everything. Many people use an annuity as an income floor and keep the rest in liquid investments.
Savers with excess retirement savings
Nonqualified annuities have no annual contribution limit. That can appeal to people who have maxed out qualified plans. For 2026, the limits are $7,500 for IRAs and $24,500 for 401(k) deferrals, with catch-up amounts at 50 and older.
No limit doesn't mean no tradeoffs. Weigh fees, liquidity, taxes, and alternative investments first.
The Drawbacks and Risks of Annuities
Fees, commissions, and surrender charges
Costs can stack up. Look in the contract or prospectus for:
- Administrative and mortality and expense charges
- Underlying fund expenses
- Rider fees and contract charges
- Sales commissions paid to the agent or broker
- Surrender charges
The SEC's variable annuity bulletin illustrates a 7% surrender charge in year one, falling a point each year, with 10% of value withdrawable free annually. Terms vary, so use the actual documents.
Limited liquidity and control
Immediate annuities generally permit no partial withdrawals or cash surrender. Deferred contracts may restrict withdrawals during the surrender period or cut guaranteed benefits when you withdraw.
Keep an emergency reserve and other liquid assets outside the annuity before committing.
Market, inflation, and insurer risks
- Variable annuities fall with their investments.
- Level payments lose purchasing power. CPI-U rose 2.7% in 2025, and Social Security's 2026 COLA was 2.8%.
- Guarantees are the insurer's obligation, not a bank deposit. Annuities are not FDIC-insured.
State guaranty associations typically cover about $250,000 in present value of fixed-annuity benefits, though limits vary (New York lists $500,000). They don't cover variable-account market losses. Check insurer ratings from AM Best, S&P, Moody's, and Fitch.
Tax and withdrawal consequences
Qualified and nonqualified money are taxed differently. Gains are ordinary income, and early withdrawals can trigger the 10% penalty. Required minimum distributions generally start at 73, or 75 if you were born in 1960 or later.
Rollovers and 1035 exchanges follow different rules. An exchange can defer gains but may restart surrender periods. Talk to a qualified tax professional before moving money.
Complexity and limited upside
Participation rates, caps, spreads, subaccounts, riders, and payout formulas make contracts hard to compare. An annuity exists to protect income and transfer risk. A growth portfolio exists to grow. Don't judge an annuity only by its illustrated return.
How to Decide Whether an Annuity Is Right for You
Start with the retirement-income gap
- Estimate the essential monthly expenses you must cover in retirement.
- Subtract dependable income such as Social Security, pensions, and rental income.
- Treat any remainder as the income gap an annuity might fill.
SSA says Social Security replaces about 43% of pre-retirement earnings for a medium earner at full retirement age. An annuity makes more sense for covering a defined shortfall than for chasing returns.
Consider age, health, timing, and household needs
There is no universally best age to buy. Timing affects payment levels, opportunity cost, and how long funds stay locked up.
Match the contract to your household:
- Health and life expectancy
- A spouse’s income needs
- Work plans and preferred start date
Those inputs point toward single-life or joint-life coverage, and an immediate or deferred start.
Compare alternatives
- Income annuity: lifetime income, little liquidity, insurer-backed.
- Pension: employer-sponsored, covered by the PBGC.
- High-yield savings: FDIC-insured to $250,000 and fully accessible, with a variable rate and no lifetime guarantee.
- Managed portfolio: flexible and growth-oriented, but market-exposed. Morningstar’s 2025 model suggests a 3.9% starting withdrawal over 30 years, with no guarantee.
These aren't interchangeable. Many plans combine several.
Review account type, beneficiaries, and legacy goals
Know whether the money comes from a taxable account, an IRA, or a 401(k). Then review rollover rules, beneficiary designations, spousal rights, and required distributions. A life-only option may leave nothing for heirs. Adding a refund, period-certain, death benefit, or joint-life feature can protect them, though it usually lowers your income.
Get a fiduciary review
Ask before you buy:
- What are all direct and indirect costs?
- What is the surrender schedule?
- What happens if I need withdrawals?
- Which benefits are truly guaranteed?
- What happens in a market decline?
- How are beneficiaries treated?
- How strong is the insurer financially?
A fiduciary adviser such as Lewis & Associates Capital Advisors, LLC can compare an annuity against your broader income and investment plan and adjust the portfolio around it as goals change. Its annuity specialists review your entire existing portfolio first. Note that the firm's fiduciary duty covers investment advisory advice, not insurance or broker-dealer services, and insurance products pay a commission.
Guidance should rest on your complete financial picture. It is not a blanket recommendation to buy an annuity.
Conclusion: Annuities Can Be Useful, but They Are Not One-Size-Fits-All
An annuity can be a strong tool when predictable lifetime income or protection from specific risks is the priority. It can be a poor fit if you need substantial liquidity, maximum growth, simple contracts, or unrestricted access to principal.
Your next steps:
- Calculate your guaranteed-income gap
- Decide how much must stay liquid
- Compare contract terms and costs
- Review the decision within your full retirement plan
Frequently Asked Questions
Are annuities a good investment?
They can suit people who want predictable income or longevity protection. Suitability depends on contract type, costs, liquidity needs, taxes, and your broader plan.
Are annuities safe if the market crashes?
Fixed contracts and many indexed floors protect against market losses. Variable annuities can lose principal. Every guarantee depends on the insurer's claims-paying ability.
How do lifetime annuities work?
You exchange a premium for payments that last for life under the contract. Age, payout option, premium, and features determine the amount.
Do you get all your money back from an annuity?
Not automatically. Total payments may be more or less than your premium depending on lifespan, payout structure, withdrawals, fees, and beneficiary provisions. Life-only payments stop at death.
At what age should you not buy an annuity?
There is no universal cutoff. Health, income timing, liquidity, tax situation, and how you plan to use the money matter more than age alone.
Is an annuity better than a pension?
They're different. A pension is an employer-sponsored benefit, often PBGC-protected, while an annuity is an individually purchased insurance contract backed by the insurer and state guaranty limits.
