Annuities Explained: Types, Rates, Pros & Cons for Retirement Income

What are annuities? Annuities are insurance contracts that convert a lump sum into guaranteed income payments, either immediately or in the future. They're one of the few financial products that can provide lifetime income you can't outlive.

In this comprehensive guide, you'll learn:

• Annuities definition and how they work
• The 4 main annuities types (fixed, variable, indexed, immediate)
• Current annuities rates and payout examples
• Annuities pros and cons for retirement planning
• When annuities for retirement income make sense

What Are Annuities? (Annuities Definition)

At its core, an annuity is a contract between you and an insurance company. You provide capital, either in a lump sum or through periodic payments, and in return, the insurer promises to make payments to you, either immediately or at some point in the future.

This simple concept has evolved into a bewildering array of products with different features, benefits, and costs. Understanding the fundamental types is essential before considering any purchase.

Annuities Rates: Current Payout Examples (2025)

Before diving into annuity types, here's what annuities rates look like today:

Annuities Payout Calculator Examples

Investment	Age	Type	Monthly Payout	Annual Yield
$100,000	65	Immediate Life	$575-625	6.9-7.5%
$100,000	70	Immediate Life	$650-700	7.8-8.4%
$100,000	65	Fixed (5-year)	Interest only	4.5-5.5%
$250,000	65	Immediate Life	$1,440-1,560	6.9-7.5%
$500,000	70	Immediate Life	$3,250-3,500	7.8-8.4%

Rates as of 2025. Actual rates vary by insurer and state.

Current Annuities Interest Rates by Type

Annuity Type	Current Rate Range	Best For
Fixed Annuities	4.5-5.5%	Conservative savers
Fixed Indexed	0-10% (capped)	Growth + protection
Immediate Annuities	6.5-8.5% payout	Retirement income
Variable Annuities	Market-dependent	Growth seekers

The Four Primary Annuities Types

1. Fixed Annuities

How they work: Fixed annuities provide guaranteed interest rates for specific periods, similar to certificates of deposit but issued by insurance companies rather than banks.

Real-world example: A 65-year-old retiree purchases a $100,000 fixed annuity with a 3.75% guaranteed rate for five years. After five years, the insurer will declare a new rate based on prevailing interest conditions.

Potential benefits:

• Principal protection
• Guaranteed interest rates
• Tax-deferred growth
• Simplicity and predictability

Potential drawbacks:

• Interest rates may not keep pace with inflation
• Limited liquidity (surrender charges for early withdrawals)
• Fully taxable as ordinary income when withdrawn (if purchased with qualified funds)

2. Variable Annuities

How they work: Variable annuities allow you to invest in a selection of "subaccounts" (similar to mutual funds) while providing a death benefit and the option to convert to lifetime income.

Real-world example: A 55-year-old investor allocates $200,000 across various stock and bond subaccounts within a variable annuity. The account value fluctuates with market performance, but a death benefit guarantees beneficiaries will receive at least the original investment if the owner dies.

Potential benefits:

• Growth potential through market participation
• Tax-deferred accumulation
• Death benefit protection
• Lifetime income options

Potential drawbacks:

• No principal protection
• Higher fees than comparable mutual funds (typically 2-3% annually)
• Complex structure and features
• Surrender charges for early withdrawals

3. Fixed Indexed Annuities

How they work: Fixed indexed annuities offer returns linked to a market index (like the S&P 500) but with downside protection. Returns are typically capped or limited by participation rates and spread rates.

Real-world example: A 60-year-old purchases a $150,000 fixed indexed annuity linked to the S&P 500. If the index rises 15% in a given year and the annuity has a 7% cap rate, the annuity would be credited with 7%. If the index falls 20%, the annuity would be credited with 0% (not losing value).

Potential benefits:

• Principal protection
• Participation in some market upside
• Tax-deferred growth
• Less volatility than direct market investments

Potential drawbacks:

• Limited upside potential
• Complex crediting methods
• Surrender charges
• Often misrepresented in sales presentations

4. Immediate Annuities

How they work: Immediate annuities convert a lump sum into a guaranteed income stream starting within 12 months of purchase. The payments can last for a specific period or for life.

Real-world example: A 70-year-old retiree uses $200,000 to purchase an immediate annuity that pays $1,150 monthly for life, regardless of how long they live.

Potential benefits:

• Guaranteed lifetime income
• Simplicity
• Mortality credits (benefiting from pooled longevity risk)
• Peace of mind

Potential drawbacks:

• Loss of liquidity
• Potential loss of principal if early death occurs
• Fixed payments may lose purchasing power to inflation
• Counterparty risk (dependent on insurer's financial strength)

Deferred Income Annuities: A Special Category

Deferred income annuities (DIAs), sometimes called longevity annuities, deserve special mention. These contracts are purchased today but don't begin payments until a future date, often 10-20 years later.

For example, a 65-year-old might invest $100,000 in a DIA that begins payments at age 85, providing approximately $2,500 monthly for life. This efficiently addresses the risk of outliving your assets in very advanced age.

Qualified Longevity Annuity Contracts (QLACs) are a specific type of DIA that can be purchased within retirement accounts with special RMD exemptions for the premium amount.

When Annuities Make Sense in a Portfolio

Annuities can serve valuable purposes in retirement planning under specific circumstances:

1. Creating Guaranteed Income

For retirees without traditional pensions, immediate or deferred income annuities can create pension-like income to complement Social Security, covering essential expenses regardless of market performance.

2. Principal Protection with Growth Potential

For conservative investors seeking some market exposure without risking principal, fixed indexed annuities may provide a middle ground between CDs and direct market investments.

3. Tax-Deferred Growth for High-Income Earners

For individuals who have maxed out other tax-advantaged accounts and seek additional tax deferral, certain low-cost variable annuities might be appropriate.

4. Legacy Planning with Living Benefits

Some annuities offer enhanced death benefits or living benefits that can address specific legacy or long-term care concerns.

When Annuities Don't Make Sense

Annuities are often sold inappropriately in situations where they don't align with investor needs:

1. Inside Qualified Retirement Accounts

Placing a tax-deferred product inside an already tax-deferred account (like an IRA) duplicates the tax benefit while adding costs and restrictions, though there are exceptions for specific income-focused annuities.

2. For Young Investors Far from Retirement

The surrender charges and higher fees of most annuities make them poor choices for younger investors who need growth and liquidity.

3. For Those Needing Liquidity

Most annuities impose significant surrender charges for early withdrawals (often 7-10% initially, declining over 7-10 years), making them inappropriate for money that may be needed in the near term.

4. As a Complete Portfolio Solution

Despite sales pitches suggesting otherwise, annuities rarely make sense as a one-size-fits-all solution for retirement planning.

The Fee Factor: Understanding the True Costs

Annuity costs vary dramatically across product types and providers. Understanding these costs is crucial for making informed decisions:

Fixed Annuities

Costs are built into the spread between what the insurance company earns on its investments and the rate it credits to you. While there's no explicit fee, this spread typically ranges from 1-2%.

Variable Annuities

These carry the highest explicit costs, including:

• Mortality and expense charges (1-1.5% annually)
• Administrative fees (0.15-0.3% annually)
• Subaccount management fees (0.5-2% annually)
• Optional rider charges (0.5-1.5% annually)

Total annual costs often range from 2-4%, significantly higher than comparable mutual funds or ETFs.

Fixed Indexed Annuities

While these don't have explicit annual fees (unless optional riders are added), the participation rates, caps, and spreads effectively limit returns, creating an implicit cost that's difficult to quantify but real nonetheless.

Immediate Annuities

The insurance company builds its profit margin and expenses into the payout rate offered. While there's no ongoing fee, the effective cost is reflected in the difference between the premium paid and the present value of expected payments.

The Surrender Charge Dilemma

Most deferred annuities impose surrender charges for early withdrawals, typically starting at 7-10% and declining over 7-10 years. These charges serve two purposes:

1. They allow the insurance company to recoup upfront commissions paid to the agent
2. They discourage short-term investing that would undermine the company's long-term investment strategy

Never purchase an annuity unless you're comfortable with the surrender period and have adequate liquid assets outside the annuity.

Tax Treatment of Annuities

The taxation of annuities adds another layer of complexity:

Non-Qualified Annuities (Purchased with After-Tax Money)

• Earnings grow tax-deferred
• Withdrawals are taxed as ordinary income on a last-in-first-out basis (earnings come out first)
• Annuitized payments are partially taxable based on an exclusion ratio (portion of each payment represents return of principal)
• No required minimum distributions during the owner's lifetime
• No step-up in basis at death

Qualified Annuities (Purchased with Pre-Tax Money)

• All withdrawals and payments are fully taxable as ordinary income
• Subject to required minimum distributions
• No tax advantages beyond those already provided by the qualified account

The Annuity Decision Framework

When evaluating whether an annuity makes sense for your situation, consider this framework:

1. Identify the specific need you're trying to address (income, principal protection, tax deferral, legacy planning)

2. Consider alternatives that might address the same need with lower costs or greater flexibility

3. Understand the trade-offs involved (liquidity, potential returns, fees, complexity)

4. Evaluate the financial strength of the insurance company (ratings from A.M. Best, Moody's, S&P)

5. Consider partial allocation rather than all-or-nothing approaches

Real-World Annuity Applications

Case Study 1: Creating a Personal Pension

Robert and Susan, both 68, have $1.2 million in retirement savings but no pension. They need $5,000 monthly for essential expenses, with Social Security providing $3,200. They used $350,000 to purchase an immediate annuity paying $1,800 monthly for life, covering their essential expense gap. The remaining $850,000 stays invested for growth, discretionary spending, and legacy goals.

Case Study 2: Longevity Insurance

Margaret, 65, is concerned about outliving her assets. She invested $100,000 from her $800,000 portfolio in a deferred income annuity that will begin paying $2,200 monthly at age 85. This allows her to plan more confidently with her remaining assets, knowing she has guaranteed income if she lives well beyond life expectancy.

Case Study 3: Conservative Growth with Protection

William, 72, has $300,000 he wants to protect from market downturns while maintaining some growth potential. He placed $150,000 in a fixed indexed annuity with a 7-year surrender period, keeping the other $150,000 in a balanced portfolio of ETFs. This approach provides principal protection for half his assets while maintaining liquidity and growth potential with the remainder.

Annuities Pros and Cons: Complete Summary

Here's a comprehensive look at annuities pros and cons to help you decide:

Annuities Pros (Benefits)

Benefit	Description	Best Annuity Type
Guaranteed Lifetime Income	Can't outlive your money	Immediate annuities
Principal Protection	No market losses	Fixed, Fixed Indexed
Tax-Deferred Growth	No taxes until withdrawal	All types
No Contribution Limits	Invest any amount	Non-qualified annuities
Death Benefits	Protect beneficiaries	Variable annuities
Predictable Income	Know exactly what you'll receive	Immediate annuities

Annuities Cons (Disadvantages)

Disadvantage	Description	Impact
High Fees	2-4% annually for variable	Reduces returns significantly
Surrender Charges	7-10% penalty for early withdrawal	Locks up your money
Limited Liquidity	Can't access funds easily	Not for emergencies
Complexity	Hard to understand terms	Easy to be misled
No Step-Up in Basis	Heirs pay taxes on gains	Less tax-efficient for legacy
Inflation Risk	Fixed payments lose purchasing power	Unless inflation rider added

Annuities Pros and Cons by Type

Type	Main Pro	Main Con	Best For
Fixed	Guaranteed rate, simple	Low returns	Conservative savers
Variable	Growth potential	High fees, market risk	Long-term growth
Fixed Indexed	Upside + protection	Capped returns	Moderate risk tolerance
Immediate	Lifetime income now	Lose principal	Retirees needing income

Annuities for Retirement Income: When They Make Sense

Annuities for retirement income work best in these situations:

✅ Good Candidates for Annuities

1. No pension - Need to create guaranteed income
2. Worried about outliving money - Longevity insurance
3. Want to cover essential expenses - Social Security + annuity = basics covered
4. Conservative investor - Can't handle market volatility
5. Maxed out other accounts - Need additional tax deferral

❌ Poor Candidates for Annuities

1. Need liquidity - May need money within 7-10 years
2. Young investors - Better options for growth
3. Already have pension - May not need more guaranteed income
4. Small portfolio - Fees eat too much of returns
5. Want to leave legacy - Better vehicles for inheritance

Frequently Asked Questions About Annuities

What is an annuity in simple terms?

An annuity is a contract with an insurance company where you give them money now, and they promise to pay you income later (or immediately). It's like creating your own pension.

Are annuities a good investment for retirement?

Annuities can be good for retirement if you need guaranteed income and don't have a pension. They're not ideal for everyone—high fees and limited liquidity are significant drawbacks.

What are current annuity rates?

As of 2025, fixed annuity rates range from 4.5-5.5%, while immediate annuity payout rates range from 6.5-8.5% depending on age. Older purchasers get higher payout rates.

What are the 4 types of annuities?

The four main types are: (1) Fixed annuities - guaranteed rate, (2) Variable annuities - market-linked, (3) Fixed indexed annuities - index-linked with protection, (4) Immediate annuities - income starts now.

What is the biggest disadvantage of annuities?

The biggest disadvantage is the combination of high fees and limited liquidity. Variable annuities can charge 2-4% annually, and most annuities have surrender charges of 7-10% for early withdrawal.

How much does a $100,000 annuity pay per month?

A $100,000 immediate annuity for a 65-year-old pays approximately $575-625 per month for life. At age 70, it pays $650-700 per month. Rates vary by insurer.

Are annuities tax-deferred?

Yes, all annuities grow tax-deferred. You don't pay taxes on gains until you withdraw money. However, withdrawals are taxed as ordinary income, not capital gains.

The Bottom Line: Are Annuities Right for You?

Annuities are neither miracle products nor toxic investments—they're financial tools that can serve specific purposes when properly understood. The key is matching the right annuity type to your specific needs.

Consider annuities if you:

• Need guaranteed retirement income
• Want principal protection
• Have maxed out other tax-advantaged accounts

Avoid annuities if you:

• Need liquidity in the next 7-10 years
• Are focused on leaving a legacy
• Can get similar benefits at lower cost elsewhere

Before purchasing any annuity, get multiple quotes, have a fee-only advisor review the contract, and understand all costs and restrictions.

Note: Annuity features and regulations are complex and subject to change. This article provides general information and should not be considered personalized advice. Consult with a qualified financial professional for guidance specific to your situation.