An annuity is an insurance product you typically buy to set aside a significant amount of money. People typically buy annuities if they:
- Need to save significantly
- Want an investment that can reduce taxes
- Want to ensure a steady flow of income
How annuities work
When you buy an annuity, you either pay a large, single premium or make payments for a period of time in exchange for a future income. Until you withdraw money or begin receiving payments, the annuity will grow on a tax-deferred basis.
When it’s time to receive your income from the annuity, you can request regular, fixed payments or take the money out in one lump sum. A popular payout option is a “lifetime income with 10 years certain.” This means the annuity pays a monthly income for the life of the annuity owner or for 10 years, whichever is longer.
What are the benefits of an annuity?
Annuities can provide three main benefits:
Death benefits
The basic death benefit offers a guarantee that when you die, the insurer — at a minimum — will pay out the amount you paid in.
Lifetime benefits
People often buy annuities with retirement in mind, because annuities can pay out in lump-sum amounts or provide a guaranteed income for as long as they live.
Tax deferral
You aren't taxed on any interest, dividends or capital gains that accumulate inside of your annuity contract until you take a withdrawal.
Many annuities have fees
Annuities have costs you need to pay each year. Before you buy, make sure you understand and ask questions about any fees you'll pay. You can review your contract or talk with your agent or broker to learn more about the fees and percentages that apply to your policy.
Surrender charges
If you cancel or cash out your annuity early, you'll need to pay a fee. It's higher in the early years of your annuity and may get lower or go away over time. This fee is usually 5% to 10% of the money you take out and the length of the policy. On average, insurers can charge this fee within seven years of opening your annuity.
Early withdrawal
If you withdraw money prior to age 59 1/2, you may be subject to an additional 10% penalty tax.
Mortality costs
This is a fee insurers charge to provide you with a death benefit.
Administrative costs
You may have to pay a separate fee for mail and services.
Investment-cost ratio
Insurers charge a fee to manage your annuity's investments.
Income tax
Withdrawals from annuities are normally taxed as ordinary income.
Additional costs of riders
Riders are additions to your annuity that provide more benefits at an additional cost.
Payout options
There are multiple payout options that may be available to you based on your contract, you should discuss your options with your agent or broker to choose the best one for you.
Learn more about annuity payout options.
Types of annuities
When you purchase an annuity you can choose to delay your withdrawals until you retire, or you can start your withdrawals immediately. You then have several options to choose from that offer different levels of risk and return.
Fixed annuities
In a fixed annuity, your money — minus any applicable charges — earns interest at rates set by the insurer. The rate is specified in the annuity contract.
Variable annuities
The insurer invests your money — minus applicable charges — in a separate account. The company invests your money in stocks, bonds or investment funds you choose, based upon your risk tolerance.
If the fund doesn't do well, you can lose all or some of your investment.
Indexed annuities
With an equity-indexed annuity (PDF 271.94KB), the insurer offers a guaranteed minimum return, plus it offers a variable rate based on the return of a specific market index. During the accumulation period, the insurer credits you with a return based on interest earned plus or minus changes in the index, subject to participation rates, caps, charges and other restrictions.
The most commonly used index is Standard & Poor’s 500 Composite Stock Price Index (S&P 500).
How to find an old annuity
Finding an existing contract can be difficult if you do not know the policy number or the name of the insurer, but we have put together tips to help you find your annuity.