What an annuity actually is

An annuity is an insurance contract. You hand an insurer a premium. In return, the insurer agrees to pay you money in the future—either as a stream of income for life, for a set number of years, or as a lump sum.

Two phases structure every annuity. The accumulation phase is where your balance grows through a fixed rate, an index, or invested subaccounts. The payout phase is where the insurer pays you back, either through withdrawals or through annuitization, which converts the contract into guaranteed income.

Most annuities sold today are deferred—you fund them now and draw income later. The other family is income annuities (SPIAs, DIAs, and QLACs), which trade liquidity for a guaranteed paycheck. We cover all three income variants in their own section below.

The three types compared

Fixed annuities, in detail

A fixed annuity credits a guaranteed interest rate set by the insurer. The dominant product today is the MYGA, which locks in a single rate for a set term—typically three to ten years. Think of it as a CD issued by an insurance company instead of a bank.

Rates on MYGAs often beat bank CDs of equivalent term. The spread varies with interest-rate conditions and the insurer’s credit strength. Rates are repriced by carriers continuously; the number quoted today is not the number quoted six months from now.

How the guarantee works

Your principal and credited interest sit inside the insurer’s general account. If the insurer fails, your money is protected by your state’s guaranty association—but only up to that state’s coverage limit, most commonly $250,000 per contract owner per insurer. Larger balances with a single carrier are exposed to insurer insolvency. The National Organization of Life and Health Insurance Guaranty Associations publishes state-by-state limits.

This matters more than many buyers realize. A fixed annuity is not FDIC-insured. You are relying on the insurer’s ability to pay. Check the carrier’s AM Best or S&P rating before signing, and consider splitting large amounts across multiple highly-rated insurers.

When a fixed annuity is the right answer

Fixed annuities work for money you don’t need for several years, where you want yield above a CD, want tax deferral, and will not tolerate market risk. They are poor substitutes for emergency savings or for money you might need within the surrender period.

Variable annuities, in detail

A variable annuity invests your premium in subaccounts—essentially mutual funds wrapped inside an insurance contract. Your balance rises and falls with the markets. No principal guarantee exists unless you buy a living-benefit rider, which we cover below.

Because variable annuities are securities, they are regulated by the SEC and FINRA in addition to state insurance law. Every variable annuity comes with a prospectus. Read it. The real cost information lives there, not in the agent’s brochure.

The fee stack

Variable annuity costs stack in layers, and the total is what matters:

• Mortality & expense (M&E) charge: typically 1.00%–1.50% per year. The insurer’s baseline fee.
• Subaccount expenses: 0.50%–1.50% per year, similar to mutual-fund expense ratios.
• Administrative fees: often a flat $30–$50 per year plus a small percentage.
• Rider fees: 0.75%–1.50% per year if you elect an income or death-benefit rider.

Add those together and the total often lands above 3% per year. At that drag, your investments must earn roughly 10% just to net 7%. Few diversified portfolios do that consistently.

Where variable annuities can make sense

A variable annuity with a GLWB rider serves a narrow buyer. That buyer wants market exposure, worries about sequence-of-returns risk in early retirement, and will pay 1%+ per year for a contractually guaranteed withdrawal floor. Outside that case, a taxable brokerage account paired with a MYGA or SPIA usually delivers a better net result.

Indexed annuities, in detail

An indexed annuity—also called a fixed indexed annuity or FIA—credits interest based on the performance of a market index, most commonly the S&P 500, without exposing your principal to market losses. The insurer limits your upside in three ways, and you need to understand all three before signing.

Caps, participation rates, and spreads

Cap rate

The maximum credit you can earn in a crediting period. If the cap is 6% and the index gains 20%, you get 6%.

Participation rate

The percentage of the index’s gain you actually receive. At a 50% participation rate, a 10% index gain credits 5% to your account.

Spread or margin

A fixed percentage the insurer subtracts from the index return before crediting. A 2% spread against a 7% index gain leaves you 5%.

Contracts often combine two of these limits. A single product may have a 10% cap and a 70% participation rate. Caps and participation rates can also be reset by the insurer each year after the first, within contractual minimums.

Crediting methods

How the insurer measures index performance changes your result more than most buyers expect. Common methods include:

• Annual point-to-point: compares the index on two dates one year apart. Simple, and usually the most favorable in strong years.
• Monthly sum: adds up monthly percentage changes, each capped individually. A single sharp down-month can wipe out an otherwise positive year.
• Monthly average: averages twelve month-end values against the starting value. Smooths returns and mutes gains in powerful bull markets.

The floor that matters

Most indexed annuities guarantee a 0% floor—you cannot lose principal to market declines. The guarantee is real, and it is why these products attract buyers burned in 2008 or 2022. What the floor does not protect against: rider fees that erode your balance in flat markets, and surrender charges that apply if you pull out early.

Income annuities: SPIAs, DIAs, and QLACs

Income annuities sit outside the fixed/variable/indexed taxonomy. They exist for one purpose: convert a lump sum into a guaranteed stream of payments. Three variants matter in 2026.

Single Premium Immediate Annuity (SPIA)

You hand the insurer a lump sum; the insurer starts paying you within a year. Payments can be set for a fixed period, for your lifetime, for the joint lives of you and a spouse, or for a lifetime with a period-certain guarantee. A SPIA is the purest form of longevity insurance sold today.

The trade-off is permanence: once annuitized, the premium is generally gone. You cannot cash it out. You are buying a contractual paycheck, not a liquid investment.

Deferred Income Annuity (DIA)

A DIA is a SPIA with a delay. You fund it now, choose a start date years or decades in the future, and wait. Because the insurer holds your premium longer, monthly payouts are meaningfully higher than a same-dollar SPIA would provide at the same start date.

DIAs appeal to pre-retirees building a future income floor: a 60-year-old can lock in payments starting at 75, insuring against the risk of market losses eroding retirement savings in the interim.

Qualifying Longevity Annuity Contract (QLAC)

A QLAC is a DIA purchased inside a qualified retirement account (IRA or 401(k)) under special IRS rules. Two benefits distinguish it from a standard DIA:

• Premium is excluded from your RMD calculation until payments begin, reducing required distributions during deferral.
• Payments can start as late as age 85, giving you up to roughly 12 years of RMD deferral past the current age-73 start.

The SECURE 2.0 Act (passed in late 2022) reshaped the QLAC rules. It eliminated the prior 25%-of-balance cap and raised the base dollar limit, which is now indexed for inflation. For 2026, the IRS limit on cumulative QLAC premiums is $210,000 per person, per IRS Notice 2025-67.

QLACs suit retirees who want to insure against outliving their savings while reducing taxable required distributions in their 70s. They are not suitable for anyone who needs liquidity or expects a shorter life expectancy—once funded, the premium is irrevocable.

How annuities are taxed

Annuity growth is tax-deferred. You pay no federal income tax on interest, dividends, or capital gains inside the contract until you withdraw. That is the primary tax benefit, and it is real.

On withdrawal, the rules depend on how the contract was funded.

Non-qualified annuities (funded with after-tax money)

Earnings come out first under the LIFO rule and are taxed as ordinary income. Your original principal comes out last, tax-free. Withdrawals before age 59½ face an additional 10% federal penalty on the taxable portion, with narrow exceptions.

All earnings are taxed at ordinary income rates, not long-term capital-gains rates. For many retirees, ordinary rates are lower than during peak earning years, but higher than the 15%–20% capital-gains rate on an equivalent brokerage holding.

Qualified annuities (funded inside an IRA or 401(k))

The entire withdrawal is taxed as ordinary income because the contributions were pre-tax. Required minimum distributions apply at the same age as for other retirement accounts. Buying an annuity inside an IRA does not create extra tax deferral—the IRA already provides that. The exception is a QLAC, which is specifically excluded from RMD calculations until payments begin.

No step-up at death

Unlike taxable brokerage accounts, annuity heirs do not receive a step-up in cost basis. Accumulated gains are taxed as ordinary income to the beneficiary. For estate planning, this matters: an annuity is often a worse asset to leave heirs than an equally sized brokerage account.

Per IRS Publication 575, annuitized payments use an exclusion ratio that splits each payment between taxable earnings and tax-free return of principal until the full basis has been recovered.

The real cost: fees and surrender charges

Every annuity has costs. Some are visible; others are priced into the product so you never see an invoice. A fair comparison requires seeing all of them.

Surrender charges

If you withdraw more than the contract’s free-withdrawal amount—usually 10% per year—during the surrender period, the insurer charges a penalty. A typical schedule starts at 7%–10% in year one and declines by one percentage point per year until it reaches zero.

Surrender periods run three to ten years on most contracts, with some stretching to fifteen. Your money is effectively locked up for that period if you want to avoid the penalty.

Market value adjustments (MVAs)

Many MYGAs and some indexed annuities include a MVA that applies on top of the surrender charge. If interest rates have risen since you bought the contract, the MVA increases your surrender cost; if rates have fallen, it can reduce it. In a rising-rate environment, MVAs can meaningfully exceed the stated surrender schedule. Check whether your contract includes one—it will be disclosed in the contract summary, usually in a single line.

Other costs to price in

• Mortality & expense charges on variable annuities.
• Subaccount expense ratios on variable-annuity investment options.
• Rider fees for guaranteed income, enhanced death benefits, or long-term care.
• Administrative fees, sometimes called contract or policy fees.
• Spreads or margins on indexed annuities, which function as fees even though the contract rarely labels them that way.

Ask for the total annual cost in writing before signing. If the agent won’t put it in writing, you have your answer.

Riders: what they do, what they cost

Riders are optional add-ons that modify the base contract. Some earn their cost; others layer fee on fee with limited benefit. Price each one against the specific problem it solves for you.

Guaranteed Lifetime Withdrawal Benefit (GLWB)

The most common income rider. It guarantees you can withdraw a set percentage of a benefit base for life, even if the actual account value runs to zero. The benefit base may grow at a guaranteed roll-up rate of 5%–7% during deferral, but that number is a phantom—it exists only for calculating the lifetime withdrawal, not for lump-sum access.

GLWBs typically cost 1.00%–1.50% per year, deducted from your account value. They suit buyers who prize guaranteed income above liquidity or legacy.

Enhanced death benefit

Guarantees your beneficiary receives at least your premium back (less withdrawals), even if market losses have pushed the account value lower. Useful if you are worried about dying in a down market. Priced at 0.25%–0.75% per year on typical variable annuity contracts.

Long-term care rider

Permits enhanced withdrawals if you meet specified care triggers. A reasonable workaround for buyers who cannot qualify for standalone long-term-care insurance, though the coverage is usually narrower than a dedicated policy.

Who each type actually fits

The right annuity depends on the job you need it to do. Match the product to the goal, not the other way around.

When a MYGA fits

You have money you don’t need for three to ten years. You want yield above a CD. You accept insurer credit risk within guaranty-association limits. You have already funded your 401(k), IRA, and any available HSA.

When a SPIA or DIA fits

You are retired or near-retired. You want guaranteed income you cannot outlive, and you value reliability above growth or legacy. A SPIA converts a lump sum into a paycheck starting within a year; a DIA does the same thing with a deferred start date for higher monthly payments. For pure longevity protection, nothing matches the efficiency of these contracts.

When a QLAC fits

You want late-life income starting at 80 or 85, and you want to shrink your required minimum distributions in the meantime. You have IRA or 401(k) money you won’t need in your 70s. You accept that the premium is irrevocable and fixed payments will lose purchasing power over the deferral period.

When a variable annuity with a GLWB fits

You want market exposure inside a tax-deferred wrapper, worry about early-retirement sequence risk, and will hold the contract long enough to offset the 2%–3% annual drag. This is a narrow case. For most buyers, a taxable brokerage account paired with a MYGA or SPIA delivers a better net outcome.

When an indexed annuity fits (rarely)

You want more upside than a MYGA, cannot tolerate any principal loss, and fully understand the cap, participation rate, spread, and crediting method in your specific contract. Indexed annuities are the most frequently mis-sold annuity type. If you cannot explain the crediting math back to the agent, do not sign.

When no annuity fits

You are under 50 with room left in tax-advantaged accounts. You need liquidity during the surrender period. You cannot explain the product in your own words. You are being pressured to 1035-exchange an existing contract without a written, buyer-focused reason for the switch.

How to buy one without getting burned

Annuities are sold more often than they are bought. Commissions on some products reach 6%–8% of premium, which shapes the recommendations you will hear. Most states now regulate this directly. Under the NAIC Model #275 Best Interest standard, adopted in 48 states as of early 2026, agents must act in your best interest and document the basis for any recommendation. Ask for that documentation in writing.

Protect yourself with a short, strict process:

1. Get the prospectus or contract summary in writing before any deeper conversation. If the agent resists, end the meeting.
2. Ask for the total annual cost—every fee, every rider, every spread—expressed as a single annualized number.
3. Request the best-interest documentation your agent is required to produce under state law. It should explain why this specific contract serves your specific situation.
4. Check the insurer’s financial strength. AM Best A- or better, and S&P A or better, is a reasonable minimum for material balances.
5. Confirm the surrender schedule year by year, including any MVA, and verify you can afford to leave the money untouched for that full period.
6. Compare at least three quotes from independent sources. Captive agents can only show you their own firm’s shelf.
7. Scrutinize any 1035 exchange replacing an existing annuity. Replacement is justified only when the new contract objectively serves you, not the agent’s commission.

A fee-only advisor who earns no commissions can review a proposed contract for a flat fee. That cost is usually recovered many times over, especially on six-figure premiums.

Common questions

Is my annuity safe if the insurance company fails?

Up to your state guaranty association’s limit—most commonly $250,000 per insurer, though amounts vary by state and by benefit type. Balances above the limit become unsecured claims in insolvency. Spreading large amounts across multiple highly-rated insurers reduces this risk.

Can I get my money out early?

Yes, but with costs. Most contracts allow penalty-free withdrawals of up to 10% per year. Beyond that, surrender charges apply during the surrender period, and federal income tax plus a 10% penalty applies on earnings withdrawn before age 59½.

Are annuities a good investment?

Annuities are insurance products, not investments in the usual sense. They excel at converting a lump sum into guaranteed lifetime income and at providing tax deferral for non-qualified money. They are generally poor substitutes for growth assets held in a taxable or Roth account.

What’s the difference between qualified and non-qualified annuities?

A qualified annuity is funded with pre-tax money inside an IRA or employer plan; all withdrawals are taxed as ordinary income. A non-qualified annuity is funded with after-tax money; only the earnings portion of each withdrawal is taxable.

What is a QLAC, and who should consider one?

A Qualifying Longevity Annuity Contract is a deferred income annuity purchased inside a retirement account under special IRS rules. In 2026, you can direct up to $210,000 of IRA or 401(k) money into a QLAC, exclude that amount from your RMD calculation, and defer the start of payments until as late as age 85. QLACs suit retirees who expect to live into their late 80s or 90s and want guaranteed late-life income while reducing taxable required distributions in their 70s.

Can I roll my 401(k) into an annuity?

Yes, through a direct rollover to an IRA annuity. The rollover itself is not taxable if executed as a trustee-to-trustee transfer. Whether it is a good idea is a separate question: you are trading investment flexibility and low-cost index fund access for an insurance contract with surrender charges and (usually) higher fees. Rollovers make sense mostly for buyers specifically seeking guaranteed lifetime income, not for maximizing portfolio growth.

How much do annuity agents make?

Commissions range from roughly 1% for short MYGAs to 6%–8% for indexed and variable annuities with long surrender periods. The commission is paid from the insurer’s margin rather than from your stated account value, but it heavily influences the product’s cost structure.

What happens to my annuity when I die?

It depends on the contract. Most deferred annuities pay the remaining account value to a named beneficiary. Immediate annuities may end at the annuitant’s death unless a period-certain or joint-life option was elected. Beneficiaries owe ordinary income tax on the gain portion; there is no cost-basis step-up.

Should I put an annuity inside my IRA?

Only if you want a specific feature the annuity provides—guaranteed lifetime income or QLAC-style RMD deferral, for example. You do not gain extra tax deferral by placing a standard annuity inside an IRA, because the IRA already shelters growth. Paying annuity fees for a benefit the IRA already supplies is rarely worth it.