Annuities explained: types, costs and how they pay
An annuity is a contract with an insurance company that can turn savings into income. Immediate versus deferred, fixed, indexed and variable, surrender charges, taxes and the questions to ask.
An annuity is a contract between you and an insurance company. You pay a lump sum or a series of payments, and in return the insurer agrees to make payments to you, starting right away or at a future date, for a set period or for the rest of your life. Annuities are mainly used for two jobs: turning savings into income you cannot outlive, and growing money tax deferred until you need it. They come with trade-offs, including limited access to your money in the early years and surrender charges, and every contractual promise depends on the financial strength of the insurance company. An annuity is not a bank deposit and is not FDIC insured.
Immediate or deferred
| Type | How it works | Often used for |
|---|---|---|
| Immediate (income) annuity | You pay a lump sum and income begins within about a year | Covering essential expenses for life starting now |
| Deferred annuity | Money accumulates first; income or withdrawals start later | Tax-deferred accumulation before retirement income begins |
Fixed, fixed indexed and variable
| Type | How interest or value is determined | Regulated as |
|---|---|---|
| Fixed annuity | The insurer credits a declared interest rate for a set period, with a minimum rate stated in the contract | An insurance product, regulated by the Colorado Division of Insurance |
| Fixed indexed annuity | Interest is linked to the performance of a market index, subject to caps, participation rates or spreads, with a floor that protects credited value from index losses | An insurance product, regulated by the Colorado Division of Insurance |
| Variable annuity | Value rises and falls with the underlying subaccounts you choose | A security as well as an insurance product; requires a securities licence to sell |
Payout options
- Life only: payments for your lifetime, ending at death. Usually the highest payment.
- Joint and survivor: payments continue for a spouse after the first death.
- Period certain: payments for a set number of years, to you or your beneficiary.
- Life with period certain or refund: lifetime payments, with a minimum paid to your beneficiaries if you die early.
- Income riders on deferred annuities: a lifetime withdrawal benefit added for a fee, without giving up the account.
Costs and limits on access
- Surrender period: if you take out more than the free withdrawal amount in the early years, a surrender charge applies. The schedule is in the contract and usually declines each year.
- Free withdrawals: many contracts allow a percentage of the value each year without a surrender charge.
- Rider fees: optional income or death benefit riders carry annual charges.
- Market value adjustments in some contracts can raise or lower what you receive on an early withdrawal.
- Free look period: after delivery you have a set number of days, stated in the contract, to cancel for a refund.
Taxes in plain English
- Growth in a non-qualified annuity is tax deferred until you withdraw it.
- Withdrawals of earnings are taxed as ordinary income, not capital gains.
- Withdrawals of earnings before age 59 and a half may face an additional 10% federal tax, with some exceptions.
- An annuity inside an IRA gets no extra tax deferral; it is bought for the income or protection features, and required minimum distribution rules still apply.
- Talk with your tax professional before moving retirement money.
When an annuity may fit, and when it may not
| May fit | May not fit |
|---|---|
| You want part of your income to last for life, alongside Social Security | You may need the money within the surrender period |
| You have maxed other tax-deferred options and want more deferral | You have no emergency fund outside the annuity |
| You want to protect part of your savings from market losses | You do not understand how the contract credits interest or what the fees are |
Questions to ask before you sign
Colorado Division of Insurance Regulation 4-1-11 requires an agent who recommends an annuity to act in your best interest, and you should receive disclosure documents explaining the contract. Take your time, ask for illustrations in writing, and never feel rushed.
- What problem is this annuity solving for me: income, accumulation or protection?
- How long is the surrender period, and what are the charges each year?
- How exactly is interest credited, and what are the current caps or rates and how can they change?
- What riders are included, what do they cost, and do I need them?
- How is the insurer rated for financial strength?
- What happens to the money if I die?
The bottom line
An annuity can be a sensible way to turn part of your savings into income you cannot outlive, but only when the money can stay put and the contract is clear to you. As part of a no-cost retirement planning review, I start with your income needs and only then look at whether an annuity belongs in the plan. Send Lisa a message or call (303) 887-8584.
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Please note: Final expense, annuity and supplemental products are subject to underwriting and carrier approval. Guarantees are based on the claims-paying ability of the issuing company. Nothing on this site is tax, legal or investment advice.