An annuity is a contract with an insurance company where you make a lump-sum payment or series of payments, and in return, the insurer provides guaranteed income payments either immediately or starting at a future date. Annuities are primarily used for retirement income planning, offering protection against the risk of outliving your savings. They come in three main types: fixed (guaranteed interest rate), fixed indexed (returns tied to a market index with downside protection), and variable (invested in sub-accounts with market risk).
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Who needs annuities?
Annuities serve people who are approaching or in retirement and want guaranteed income they cannot outlive. If Social Security and any pension do not fully cover your monthly expenses, an annuity can fill the gap with predictable payments. They are also valuable for risk-averse savers who want tax-deferred growth without stock market volatility (fixed and fixed indexed annuities). For workers who do not have pension plans and rely on Social Security and personal savings, annuities can provide the income floor that creates retirement confidence. The Way Agency works with clients to determine whether an annuity belongs in their retirement plan and, if so, which type and how much of their savings to annuitize. We are transparent about the tradeoffs, including fees, surrender charges, and liquidity limitations.
What does annuities cover?
- Guaranteed income payments for life or a set period (depending on payout option selected)
- Tax-deferred growth on earnings until withdrawal
- Fixed annuities: Guaranteed minimum interest rate (typically 3-5% in current rate environment)
- Fixed indexed annuities: Returns linked to market index (e.g., S&P 500) with a 0% floor (you cannot lose money to market declines)
- Death benefit to beneficiaries if you die before or during the payout phase
- Optional riders for enhanced income, long-term care benefits, or inflation adjustment
What annuities does NOT cover
- Annuities are not FDIC insured (they are backed by the financial strength of the issuing insurance company)
- Variable annuities carry investment risk and can lose value
- Early withdrawals before age 59 1/2 may incur a 10% IRS penalty plus ordinary income tax
- Surrender charges apply if you withdraw more than the free withdrawal amount (typically 10% per year) during the surrender period (often 5-10 years)
- Inflation can erode the purchasing power of fixed payments unless an inflation rider is added
- Annuity income is taxed as ordinary income, not at capital gains rates
What does annuities cost?
Annuities do not have a straightforward monthly premium like insurance policies. You either invest a lump sum (common with money from a 401(k) rollover, inheritance, or savings) or make scheduled contributions over time. Fixed annuities typically have no explicit fees but earn lower interest than you might get in riskier investments. Fixed indexed annuities may have caps on returns (for example, a 6 to 8% cap on annual gains) and participation rates. Variable annuities carry annual fees of 2 to 3% including mortality charges, administrative fees, and fund management expenses. Surrender charges range from 5 to 10% in the first year, declining to zero over 5 to 10 years. The Way Agency explains all costs in plain language and only recommends annuities when the guaranteed income benefit justifies the tradeoffs.
Frequently asked questions
A fixed annuity pays a guaranteed interest rate for a set period, similar to a CD but with tax-deferred growth. A fixed indexed annuity ties your returns to a market index like the S&P 500, with a floor (typically 0%) that protects against losses and a cap (typically 6 to 10%) that limits gains. Fixed annuities are simpler and more predictable. Fixed indexed annuities offer higher growth potential but are more complex. Neither can lose principal to market declines.
Immediate annuities begin paying income within 30 days of your lump-sum deposit. Deferred annuities accumulate value over a period you choose (5, 10, 20 years or more) before you begin taking income. You can annuitize a deferred annuity into lifetime income or take systematic withdrawals. Most people purchase deferred annuities in their 50s and begin income in their 60s or later.
Annuities are backed by the financial strength of the issuing insurance company, not by the FDIC. Every state has a guaranty association that protects annuity owners up to certain limits (typically $250,000 in present value of annuity benefits) if a carrier becomes insolvent. The Way Agency recommends annuities only from carriers with strong financial ratings (A-rated or better by AM Best) to minimize this risk.
Most annuities have a free-look period of 10 to 30 days after purchase during which you can cancel for a full refund. After that, surrender charges apply to withdrawals beyond the annual free withdrawal amount (typically 10% of the account value per year). Surrender periods last 5 to 10 years. After the surrender period ends, you can access your full account value without penalty. Always understand the surrender schedule before purchasing.
If you purchased the annuity with after-tax money, a portion of each payment is a return of your principal (not taxed) and a portion is earnings (taxed as ordinary income). If the annuity was purchased with pre-tax money (from a 401(k) or traditional IRA rollover), the entire payment is taxable as ordinary income. Withdrawals before age 59 1/2 may also be subject to a 10% IRS early withdrawal penalty.
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Related coverage to consider
- Whole Life - Permanent life insurance that covers you for your entire life with level premiums, a guaranteed death benefit, and cash value that grows over time.
- Term Life - Pays a death benefit to your beneficiaries if you die during the policy term (typically 10, 20, or 30 years).
- Disability Insurance - Replaces a portion of your income (typically 50–70%) if you're unable to work due to illness or injury.
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Reviewed by
Sheilia Royal, Agency Principal / Licensed Agent
Licensed in KY, IN & TN | 20 years experience | Last reviewed: March 2026