What Are the Main Types of Annuities?
Annuities fall into several categories:
- Fixed annuities — guaranteed interest rate and predictable payments
- Variable annuities — payments tied to investment portfolio performance
- Indexed annuities — returns linked to a market index with downside protection
- Immediate annuities — income starts within a year of purchase
- Deferred annuities — income begins at a specified future date
Each type offers different trade-offs between growth potential, risk, and guaranteed income.
What Are the Pros and Cons of Annuities?
Advantages: guaranteed lifetime income eliminates longevity risk, tax-deferred growth, no contribution limits, and death benefits for heirs. Disadvantages: high fees (especially variable annuities at 2-3% annually), surrender charges for early withdrawal, complexity, limited liquidity, and returns that may underperform direct investing. Many professionals suggest comparing total costs before purchasing.
Who Should Consider an Annuity?
Annuities make the most sense for retirees or near-retirees who want guaranteed income beyond Social Security and pensions. They are particularly valuable if you are risk-averse, worried about outliving savings, or lack a pension. They are generally not appropriate for young investors, people with high-fee sensitivity, or anyone who may need the money before the annuity's term.
Frequently asked questions
Can I lose money in an annuity?
With fixed annuities, your principal is protected by the insurance company's guarantee. Variable annuities can lose value if the underlying investments decline, though many include optional guaranteed minimum income riders for an additional fee. The insurance company's financial strength matters — check their AM Best rating.
What happens to my annuity when I die?
It depends on the contract. Life-only annuities stop paying at death — remaining funds stay with the insurer. Joint-and-survivor annuities continue paying a surviving spouse. Many annuities offer death benefits that return remaining value to beneficiaries. Choose the payout structure carefully based on your family situation.
Are annuity payments taxed?
Yes. The tax treatment depends on how you funded the annuity. Payments from annuities purchased with pre-tax money (like an IRA rollover) are fully taxable as ordinary income. For annuities purchased with after-tax dollars, only the earnings portion of each payment is taxed. Withdrawals before age 59.5 may incur a 10% penalty.