What is an annuity?

An annuity is a contract with an insurance company where you pay a lump sum or a series of payments, and the insurer pays you back — either immediately or in the future — over a set period or for life. They're primarily used to generate guaranteed retirement income.

An annuity is a contract between you and an insurance company. You give the insurer money — either a single payment or a series of payments — and in exchange, the insurer agrees to pay you income, either starting right away (immediate annuity) or at a future date (deferred annuity). Annuities are insurance products, not bank accounts or brokerage accounts, and they are regulated at the state level by state insurance commissioners.

The main types of annuities

Fixed annuities pay a guaranteed interest rate during the accumulation phase and then guaranteed payments in retirement. Variable annuities invest your premiums in subaccounts (similar to mutual funds); your returns — and payments — vary with market performance. Fixed-indexed annuities credit interest tied to an index like the S&P 500, with a floor so you don't lose principal due to negative index performance. The SEC's investor guide to annuities explains each type and associated fees in plain language.

How annuity income works

Once you annuitize (convert your contract to a payout stream), you choose a payout option: income for a fixed period, income for life, or income for your life with a minimum period guaranteed. The insurer calculates payments based on your age, account value, interest rates, and the payout option you select. A lifetime annuity guarantees you cannot outlive the payments — a feature that has real value if longevity is a concern. Payments from a tax-deferred annuity are taxed as ordinary income when received. IRS Publication 939 covers the taxation rules for annuity payments.

What to watch out for

Annuities often carry surrender charges — fees for withdrawing money early, which can last 7–10 years and run 7–10% of the contract value. Variable annuities typically carry mortality and expense (M&E) fees, administrative fees, and subaccount expenses that can total 2–3% per year. The SEC's annuity resources cover costs and questions to ask before purchasing.

Fixed: guaranteed rate, predictable payments. Variable: market-linked, payments fluctuate. Fixed-indexed: index-linked with a floor.
Lifetime payout options guarantee income you cannot outlive.
Surrender charges can lock up funds for 7–10 years with significant penalties for early withdrawal.
Tax-deferred growth inside an annuity; distributions taxed as ordinary income.
Annuities are insurance products regulated by state insurance commissioners, not FDIC-insured.

What regulators say

Annuities are insurance contracts sold by insurance companies and are not insured by the FDIC. They are regulated by state insurance commissioners. — SEC / Investor.gov
Variable annuities involve investment risk, including the possible loss of principal. Their value fluctuates with the performance of the underlying investment options. — SEC / Investor.gov
Annuity payments received under an annuity contract are generally fully or partly taxable as ordinary income in the year received, depending on whether premiums were paid with pre-tax or after-tax dollars. — IRS Publication 939

Key takeaways

An annuity converts a lump sum into a guaranteed income stream — useful for covering fixed expenses in retirement.
Fixed annuities guarantee a rate; variable annuities tie payments to market performance; fixed-indexed annuities offer index-linked upside with principal protection.
Lifetime payout options ensure you cannot outlive your income, but surrender charges can lock up your money for years.
Annuities are not FDIC-insured — they're backed by the financial strength of the insurance company that issues them.
Compare total fees (M&E charges, administrative fees, subaccount expenses) carefully before purchasing a variable annuity.