What Are Annuities? What to Know About This Confusing Retirement Strategy

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Life expectancy has risen in the last 4 decades — and with the expectation that Americans will be living longer, building and protecting your retirement savings is more important than ever. 

That’s why you should take a (skeptical) look at products like annuities. These are insurance products that provide a safety net during retirement. Annuities promise a guaranteed income stream for however long a person elects coverage, or until they die. These plans can be owned by individuals or with spouses, and some offer the option of electing beneficiaries. But they can be extremely complicated to understand.

“Here’s the problem with annuities: there’s so much complexity and lots of fees involved,” says Jill Schlesinger, Certified Financial Planner and host of the “Jill on Money” podcast. “This is where the annuity investing and product gets thorny. It requires the purchaser of that annuity to really go through and understand all the different aspects of it. It can add a higher level of costs than investing in index or mutual funds.”

Just like other personal finance products out there, annuities make sense for some people. If you plan to go the annuity route, take your contract to a fiduciary financial advisor, someone who can give you advice with your best interests in mind. 

“This investment vehicle is favored by financial experts and economists for many reasons, but in truth is only realistic for a small percentage of the population,” says Chris Anderson, a senior investment advisor at Harbourfront Wealth Management.

Continue reading to learn more about annuities, how they can potentially benefit you in your golden years and what to look out for when choosing an annuity plan.

What Are Annuities?

To put it simply, annuities ensure that you have a steady stream of income during your retirement. It’s a long term contract between an individual and an insurance company that grows on a tax-deferred basis which provides a guaranteed income stream for life. There are a few different options to choose from.

“Think of annuities as doughnuts. There is a wide variety, and they differ in structure, profile, length, cost, etc,” says Anderson.

When you have an annuity, you first pay a sum of payments to the insurer. Whatever type of annuity you purchase dictates when you begin to receive those payments. Payments can come in monthly, quarterly, or annually. Annuities ensure you won’t outlive your money. Low-cost annuities are available as well.

“When obtaining an annuity plan, individuals starting in their 40s sign a contract where they agree to make either a lump-sum payment or a series of installments to a provider,” says Anderson. “Starting premiums can range from $10,000 to $40,000. From there, you’ll receive regular disbursements.” 

There are two stages in the annuity process. The first stage is called the accumulation stage, where you pay premiums. Typically, once you enter into an agreement, you cannot switch to another annuity product, get a refund or cancel the plan, unless the plan allows for it, in which case you may have to pay a penalty. Once premiums are paid, the next phase begins, in which the plan starts disbursing funds to you. This is called the distribution state. It’s the process of converting your annuity into monthly payments.

Although people can opt into annuities plans earlier in life, they cannot withdraw any funds from their plans before the age of 60 without penalties, similar to a 401(k).

Types of Annuities

Annuities can be split into four types: Fixed annuity, variable annuity, immediate annuity and deferred annuity. Each determines a different monthly payout. 

  • Immediate annuity — The key thing to remember is that annuities create a stream of income at some point in your life. With immediate annuities, you dump a bunch of money into an insurance company and that company will spit out a monthly or annual income based on terms agreed to. “You put the money in and immediately a stream of income starts flowing,” says Schlesinger. 
  • Deferred annuity — With a deferred annuity, you put money in either all at once or along the way and at some point in the future, a stream of income begins. 
  • Fixed annuity — There’s a fixed interest rate associated with it.  “In other words, when the index is up, your account will be up — when the index is down, your account remains the same, and the index calculation resets for another year,” says Mark Charnet, a certified annuity specialist and founder and CEO of American Prosperity Group, a retirement planning firm. 
  • Variable annuity — Variable annuities are for investors willing to take more risk.  The way that the contract is valued is derived from variable investments, like stock market investments. “The account value will fluctuate based on the performance of the underlying investments,” says Akhil Kumar, vice president and CCO at Arch Global Advisors, a wealth management company. This type of annuity can offer higher returns, but with the possibility of the account falling in value.

Fees will also depend on the type of plan you choose. Index annuities fees can range from 1 to 2 percent, and variable annuities fees can be up to 4 percent. Additional death or income benefits can add to the cost. Companies may take a share of gains and reduce your return on a sliding scale. There are also no-fee annuities that only take a share of the gains.

Should I Get An Annuity?

There is no right answer to this question. Personal finance is a very individualized decision. Even though annuities offer a sense of protection, it’s best to reach out to a financial advisor for more specific answers to these types of questions. 

Doing research can help you understand more about annuities. Here are some pros and cons.

Pros & Cons of Annuities


  • Stable source of retirement income

  • Can assign beneficiaries in case of death

  • Much of the income is taxed at typical rates or not at all

  • Alleviates anxiety associated with investing


  • Plans can be costly

  • Payments are on a schedule

  • Annuities products can be hard to understand

  • Loss of access to liquid cash

How Are Annuities Taxed?

Annuities are tax-deferred, meaning they are only subject to income tax when funds are withdrawn. 

“The income payments are a combination of principal and interest called the ‘exclusion ratio’ based on the amount of gain in the contract,” says Mindy Tankel, a certified financial planner and director of wealth management at Aspiriant, a financial planning company. “The return of the principal amount of the payment is not taxed. The gain portion is taxed as ordinary income.”

The exception is annuities based on Roth IRAs, which grow and can be withdrawn without tax, according to Myers.


For those looking for a steady, low-risk form of retirement income, annuities can be an option. Keep in mind that there are fees associated with annuities. If you’re interested in learning more, make sure to research to find an annuity plan that’s right for you and speak to a fiduciary financial advisor.