What Are Annuities and Are They a Good Option for Retirement Income?

When you buy an annuity contract, you give money to an insurance company. In return, the company promises to pay you income. Payments may start right away or at a future date. The amount depends on how much you put in, the type of annuity, and the strength of the insurance company.

There are two broad types:

• Immediate annuities: You make one payment and income starts within 30 days. This works well for people who need income right now.
• Deferred annuities: Your money grows over time before income begins. These are built for people who want to save now and start income later.

Fixed annuities pay a set interest rate for a set period. They offer steady, fixed income with no market risk. Think of them as the safest option.

Fixed indexed annuities tie growth to a market index (like the S&P 500). They protect your principal from losses. You get some upside with downside safety. A retirement annuity like this can appeal to people who want growth without full market risk.

Variable annuities invest in market sub-accounts. Your returns and income go up and down with the market. They offer the highest growth potential. They also carry the highest risk and the highest fees.

Annuities come with costs you should know before you commit. Here are the most common:

• Surrender charges if you pull money out early (often lasting 5 to 10 years)
• Yearly admin fees
• Mortality and expense charges (on variable annuities)
• Rider fees for extra features like lifetime income guarantees

Once you put money into an annuity, getting it back early can cost a lot. Make sure you keep enough liquid savings outside the annuity to cover surprise costs. That is a key part of doing this right.

An annuity can be a good fit if you need guaranteed income that lasts for life. It works best for people who have already maxed out other savings options. It also helps those who want a steady check to pair with Social Security.

An annuity is not ideal if you need quick access to your cash. It is also not the best choice if the fees eat too much of your returns. The key is to match the product to your specific needs and goals.

Annuities can play a role in your estate plan. But there are tax effects to know. When a non-spouse beneficiary (the person who receives assets after you pass) inherits an annuity, the gains inside the contract are subject to income tax. Unlike other assets, annuities do not get a stepped-up basis at death.

For people on a fixed income who need guaranteed payments for the rest of their life, an annuity may fill a real need. But it is one piece of a larger plan. For a broader look at retirement and estate planning, read our guide on trusts vs. wills. The right tool depends on the goal.