Annuities
How annuities work, and which kind fits which job
An annuity is a contract with an insurance company. You give it money, and in return it protects that money, grows it at a set or index-linked rate, pays you income, or some mix of the three. The kind you choose depends on which of those jobs you need done.
The three kinds I work with
My practice focuses on fixed and fixed index annuities, which are insurance products. Variable annuities are securities and a different conversation.
| Fixed-rate (MYGA) | Fixed index | Income annuity | |
|---|---|---|---|
| How it grows or pays | A set interest rate for a set term | Interest linked to a market index, up to a cap or rate | Turns a lump sum into payments, now or later |
| Market drops | No effect | Zero credited that period; no loss from the index | No effect on payments |
| Typical term | 2 to 10 years | 5 to 10 years | For life, or a set period |
| Best known for | Predictable growth | Protection with some upside | Income you can't outlive |
Fixed-rate annuities · Fixed index annuities · Income annuities
The fine print, in plain English
Every annuity trades some access to your money for protection, a guaranteed rate or income. Most contracts let you take out about 10% a year without a charge. Take more than that during the surrender period, usually the first 5 to 10 years, and a surrender charge applies. That charge typically starts around 7% to 10% and steps down each year until it reaches zero.
That's why an annuity is the wrong home for your emergency fund or money you'll need in the next few years. It works best for savings you've set aside for retirement and won't need to touch all at once.
What annuities cost
- Fixed-rate and fixed index annuities usually have no annual management fee. The insurer's cost is built into the rate, cap or participation rate it offers.
- Optional riders, such as a lifetime income rider, usually carry an annual fee, commonly around 1% of a benefit amount.
- Surrender charges apply only if you withdraw more than the free amount during the surrender period.
How annuities are taxed
Growth inside an annuity is tax-deferred. You pay ordinary income tax on the gains when you take money out, not each year as it grows. Withdrawals before age 59½ may also face a 10% IRS penalty on the taxable part.
If the annuity is inside an IRA, it follows IRA rules: withdrawals are taxable, and required minimum distributions apply. The rollover guide covers this in detail.
How I'm paid
The insurance company pays me a commission when you buy an annuity. You don't pay me a fee, and on the fixed and fixed index annuities I offer, the commission isn't deducted from the money you put in. I'll tell you how it works on any product I suggest.