Retirement and uncertainty go together about as well as mustard and chocolate. Which is to say, when you have the chance to reduce the variability of your income streams in retirement, it’s worth considering. Enter: the annuity.
Annuities are among the most commonly misunderstood and misused financial products. They can provide a host of benefits, from guaranteed income to some downside protection from market swings. But the term “annuity” encompasses a wide range of products with varying features, costs, risks and restrictions.
[Sign up for stock news with our Invested newsletter.]
The trouble is annuities are often sold and not bought. Consumers may be pushed into ill-fitting products because that’s what a broker is selling that month. That means the burden is still on consumers to be careful, ask questions and ensure that any product they choose matches their needs. Consulting a financial advisor is also a good idea. Let’s look at the different types of annuities, how they work and whether they make sense for you.
Here are 10 things you need to know before buying an annuity:
— Start with what you need the annuity to accomplish.
— What are the different types of annuities?
— Match your goal to the annuity.
— Know what is actually guaranteed.
— How does a contract rider provide additional benefits?
— Understand annuity fees and compensation.
— How are annuities taxed?
— Understand the rules for accessing or getting your money back.
— Verify the professional and anything AI tells you.
— Is an annuity right for you?
Start With What You Need the Annuity to Accomplish
Like ice cream, there are many flavors of annuities, and each customer can have a different preference. This is why Tamiko Toland, founder and CEO of 401(k) Annuity Hub, says the first question to ask isn’t which annuity to buy, but rather what you want the annuity to do for you.
Do you want guaranteed income for life? A safe place to put your savings? Tax-deferred growth? A bit of downside protection from market swings? “The answers to these questions and your own understanding of your preferences for certainty or risk-taking will then make it clear what type of product fits,” Toland says.
What Are the Different Types of Annuities?
Annuities can be categorized in several ways, including when payments begin, how the contract’s value grows and how the income is ultimately provided. Annuities can also fall into one of two camps based on when they start paying income:
— Immediate annuities are annuitized, meaning converted to an income stream for the buyer, immediately. These are usually purchased with a lump sum and payments often begin within one year.
— Deferred annuities begin paying income at a future date determined by the owner. These have an “accumulation period” during which the owner can continue to add funds and that money grows tax-deferred.
Annuities can also be categorized based on their interest structure:
— Fixed annuities pay a guaranteed minimum rate of return and provide a fixed series of payments under conditions determined when you buy the annuity.
— Variable annuities have their performance and eventual return based on underlying investments in mutual funds.
— Fixed indexed annuities have a minimum guaranteed rate of return with total returns based on an underlying index like the S&P 500.
— Registered index-linked annuities, or RILAs, have their returns linked to a market index and include a specified level of downside protection. Unlike fixed indexed annuities, however, RILAs can lose value.
These categories can overlap. For example, an annuity can be both fixed and deferred.
Annuities Have Payment Options
There’s a lot of flexibility in how annuity payments are handled. Annuities can make payments for a fixed number of years to you or your heirs or for the rest of your life. They can also provide a combination of both lifetime income with a guaranteed “period certain” payout. A “life with period-certain annuity” pays you income for life, but if you die during a specified time frame (the period-certain years), the annuity will pay your beneficiary the remainder of your payments.
[Read: 7 Best Fidelity ETFs for Retirees]
Match Your Goal to the Annuity
With the different types of annuities in mind, you can start to match your goal to the right product type. For example, “someone who is interested in guaranteed income primarily should start by looking at an income annuity or a fixed annuity with an income benefit,” Toland says. Meanwhile, if you just want principal protection for your savings, she says a fixed annuity without an income benefit could be better.
This table may help get you started:
| Primary Goal | Annuity to Consider First | Principal Trade-Off |
| Lifetime income beginning soon | Fixed immediate annuity | Returns are typically lower than in the equity or bond market; inflation may erode purchasing power. |
| Guaranteed income beginning later | Deferred income annuity or deferred annuity with a guaranteed lifetime-income rider | Liquidity, rider costs and benefit rules vary; withdrawals may reduce future guaranteed income. |
| Predictable interest and principal protection | Fixed-rate deferred annuity | Initial rate may apply only for a set period; early withdrawals may trigger surrender charges or adjustments. |
| Market-linked interest without direct losses from a declining index | Fixed indexed annuity | Upside potential may be limited by caps, participation rates or other rules. |
| Market-linked growth with some downside protection | Registered index-linked annuity (RILA) | You may lose money; gains may be limited. |
| Market-based growth now and guaranteed income later | Variable annuity with an income benefit | Higher annual expenses than most mutual funds; may lose money. |
Know What Is Actually Guaranteed
Most people buy an annuity for its guarantee, but the word “guaranteed” can refer to many different features, so buyers need to identify exactly what a contract promises and what it doesn’t.
An annuity’s income benefit, for example, doesn’t necessarily guarantee that its account value will remain intact. A guaranteed income lifetime withdrawal benefit may allow you to withdraw a specified amount for life, even if poor investment performance and withdrawals eventually reduce the contract value to zero.
Before signing, ask the person selling the annuity to you to identify the contract’s:
— Current account or contract value
— Cash surrender value
— Income benefit base (a bookkeeping value used to calculate guaranteed income)
— Guaranteed annual withdrawal or income adjustment
— Conditions that could reduce or end each guarantee
The other trouble with guarantees is that they are never absolute. It’s the insurance company (not the federal government) that guarantees annuity payments. So when you buy a retirement annuity, consider the financial strength of the insurer.
States have guarantee associations that cover an insurer’s annuity obligation to a state-determined coverage level limit. While coverage levels vary, most states cover at least $250,000.
How Does a Contract Rider Provide Additional Benefits?
You can attach additional benefits or protections to your annuity contract through contract riders. Riders can be used to enhance an annuity’s income, legacy or long-term-care provisions.
For example, an income rider attached to a deferred annuity enables you to turn on your lifetime income stream whenever you want instead of the age you specified when you signed the contract. Meanwhile, with a death benefit rider, if you die before the annuity has returned all of your premium payments, the insurance company will pay your estate or beneficiary the difference.
“There are no ‘good’ or ‘bad’ features,” Toland says. “They all have situations where they work well and can really provide a benefit, even if they are expensive.” The important question is whether the rider solves a need you have and if you understand the trade-offs.
Before adding one, ask what triggers the benefit, what it costs and whether withdrawals could reduce or eliminate it. And all riders come with an additional fee that’s charged for the life of the policy. So be sure to determine whether the rider increases the amount available to you or merely changes how you can access the contract’s value.
A financial professional should be able to explain not only why the feature fits your financial situation today, Toland says, but also how to use it when the need arises.
Understand Annuity Fees and Compensation
Annuity costs are not always easy to spot. Variable annuities may charge contract fees, underlying investment expenses and fees for optional riders. Meanwhile, fixed annuities, fixed indexed annuities and RILAs don’t always have explicit ongoing fees, but they may carry indirect costs, such as lower credited interest, caps or other limits on potential gains. Surrender charges and contract adjustments can also reduce the amount you receive if you withdraw money early.
The best approach is to ask for a written explanation of every explicit and implicit cost and how each one could affect your return before purchasing. Also ask whether a bonus or enhanced benefit comes with higher expenses, a longer surrender period or less favorable contract terms.
The professional selling the annuity may also receive a commission, advisory fee or other compensation. Don’t be afraid to ask them outright how they’re compensated and whether they would earn more by selling one annuity or contract rather than another. Compensation schemes can create a potential financial incentive for the professional to recommend one over another.
Most importantly of all, remember that just because an annuity doesn’t have a visible commission or annual fee doesn’t mean it’s cost-free.
How Are Annuities Taxed?
Annuities are tax-deferred, which means you don’t pay taxes on the money while it’s in the annuity. Like a 401(k) or traditional IRA, you only pay taxes on the money when you withdraw it.
If you fund your annuity with pretax dollars, called a “qualified annuity,” then everything you withdraw will be taxed at your ordinary income rates. If, however, you used after-tax dollars to fund your annuity, called a “nonqualified annuity,” you won’t be taxed on the portion of your withdrawal that represents a return of your original principal. Only your earnings will be taxed in a nonqualified annuity.
Qualified annuities held inside qualified retirement accounts, like traditional IRAs, or those funded with pretax dollars are considered “retirement accounts” by the IRS. This means they are subject to the IRS’ required minimum distribution, or RMD, rules.
The RMD age is 73 (rises to 75 for those born in 1960 or later). If a retiree or beneficiary misses a required withdrawal, the IRS excise penalty was lowered from 50% to 25% (and drops to 10% if corrected in a timely manner).
If a qualified annuity is held in a retirement plan, the beneficiary will also be subject to this penalty tax if they fail to take withdrawals in time. And they’ll need to abide by inherited retirement account rules, such as time limits on when the account must be fully emptied.
Non-spouse beneficiaries who inherit a qualified annuity must generally follow the 10-year rule established by the SECURE Act. It requires the entire account balance to be distributed by the end of the 10th year following the owner’s death (unless the beneficiary qualifies for an exemption, such as a disabled individual). Nonqualified annuities have more flexible rules.
[Read: 7 Best Blue-Chip Dividend Stocks to Buy in 2026]
Understand the Rules for Accessing or Getting Your Money Back
Like certificates of deposit, or CDs, deferred annuities have surrender charges if you withdraw your money early. Surrender periods vary from two years to 10 years or more, and the corresponding charges typically decline with time. For example, a deferred annuity with a 10-year surrender period could charge 10% on money withdrawn the first year, 9% the second year, 8% the third year and so on.
However, some contracts may have a free withdrawal feature that lets you take out a portion — such as 10% — of your contract each year.
Bear in mind that as with IRAs and 401(k)s, earnings withdrawn before age 59½ may be subject to a 10% federal tax penalty.
If you end up in an annuity that isn’t right for you, you can always get out free of charge during the free-look period. The free-look period is the length of time annuitants can receive a full refund of their contracts. If you cancel during the free-look period, you get everything you paid back, no questions asked. Free-look periods vary by state and most are anywhere from 10 to 30 days.
Verify the Professional and Anything AI Tells You
“One of the biggest changes to retirement planning is the availability of AI-assisted explanations and strategies,” Toland says. White AI can help explain annuity terminology and suggest questions to ask, it’s best not to use it to interpret a specific contract or determine whether a product fits your goals.
“I don’t want to discourage people from feeding their curiosity,” Toland says. But AI-generated information may be inaccurate or omit important contract conditions. She encourages people to seek out reliable sources of information and always talk to a professional.
Any professional you speak to “should be able to explain their qualifications, including training and licensing, and their compensation,” she says. They should also be able to clearly tell you why a particular annuity fits your needs and what alternatives are available.
“You should feel that they understand your personal needs and goals,” Toland says, and any plan or product they suggest should meet those objectives.
Is an Annuity Right for You?
Annuities aren’t for everyone. If you aren’t worried about running out of income — for example, if you have enough money from Social Security and other retirement assets — you may not need an annuity.
Likewise, if you don’t expect to reach your life expectancy, an annuity may not make sense, unless you have a spouse you want to provide for.
If you do buy an annuity, make sure you have enough other funds available to cover emergencies and near-term expenses.
More from U.S. News
Fixed Index Annuity: Why It’s Gaining Popularity Now
7 High-Return, Low-Risk Investments for Retirees
7 Best Fidelity ETFs for Retirees
Are Annuities a Good Investment? 10 Things to Know Before Buying originally appeared on usnews.com
Update 07/24/26: This story was published at an earlier date and has been updated with new information.
