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Annuities are experiencing a resurgence as retirees seek stable income sources due to factors like stock market volatility and economic uncertainty. From 2022 through 2024, the U.S. annuity industry saw three consecutive years of record-breaking sales, totaling over $1.1 trillion.
However, annuity contracts remain famously complex, with restrictions that can be costly if you don’t do your due diligence. Here’s what you should know before committing, including the different annuity types, their pros and cons, and how to assess which option fits your needs.
Key Takeaways
- Annuities are contracts with insurance companies that can provide reliable income in retirement.
- Fixed annuities invest in conservative assets and offer guaranteed payments, while variable annuities carry market risk in exchange for higher growth potential.
- Immediate annuities deliver payouts soon after purchase, while deferred annuities offer an extended accumulation phase.
- The right annuity should match your income needs, risk tolerance, and financial goals, so it fits into your overall retirement strategy and
- A financial advisor can help you navigate the customizable riders and fee structures that make annuities so complex.
Understanding Annuities
Annuities are insurance contracts designed to provide a steady stream of income, typically in retirement. You fund them with a lump sum or series of premiums, and in return, an insurer makes regular payouts to you for a predetermined period, which can be as long as the rest of your life.
The primary purpose of annuities in retirement planning is to help manage longevity risk—the possibility of outliving your savings. “With the AI era upon us, medical advancements could potentially result in much longer lifespans than previously thought,” said Marcel Miu, CFA, CFP, founder of Simplify Wealth Planning.
Annuities can also supplement other fixed income sources, such as Social Security benefits, pensions, or bonds. For many retirees, some amount of predictable income can provide peace of mind.
Types of Annuities
Fixed Annuities
Fixed annuities provide payouts that remain the same regardless of market fluctuations. Their issuers invest your premiums in conservative assets—such as high-quality corporate and government bonds—and pay you a static amount on a regular schedule, typically monthly.
This low-risk investment approach allows insurers to guarantee your recurring payments, offering predictability. However, fixed annuities often provide lower returns than other investments, and their payouts may struggle to keep pace with inflation.
A common variation of the fixed annuity is the fixed indexed annuity (FIA), also called an indexed annuity. While FIAs protect your principal and offer a guaranteed minimum return, a portion of your interest is also linked to the performance of a market index, like the S&P 500. If the index performs well, your interest may increase, giving you the potential for higher returns.
Variable Annuities
In contrast to fixed annuities, variable annuities invest your premiums in market-based assets, such as mutual funds. As a result, your future payouts and the value of your account will depend on how these underlying investments perform.
While this introduces market risk and the potential for losses, it also means variable annuities provide greater growth potential than fixed annuities. As a result, they may appeal to investors with a higher risk tolerance or a longer time horizon, but they come with added complexity.
Important
Beyond the risk of losses, a major drawback of variable annuities is their tendency to carry higher fees than other annuity types.
“I generally avoid variable annuities due to their high costs, even though they offer a range of investment options,” said Zach Swad, CFP, CWS, founder of Swad Wealth Management.
Immediate Annuities
Immediate annuities—available in fixed and variable forms—are characterized by a payout phase that starts soon after purchase, generally within one year. You typically fund immediate annuities with a lump-sum payment.
These contracts can be ideal for retirees or near-retirees who want to quickly convert a portion of their savings into a reliable stream of income.
Deferred Annuities
Deferred annuities don’t begin payouts for a potentially years-long period known as an accumulation period, during which your invested premiums grow tax-deferred. Like immediate annuities, deferred annuities can offer fixed or variable returns.
Because you can fund deferred annuities over an extended period, they may be a more suitable vehicle for building long-term retirement savings than immediate annuities.
Choosing the Right Annuity for You
Risk Tolerance and Investment Goals
Selecting the right annuity begins with self-analysis. “Most people approach annuities backward,” said Miu. “They focus solely on the product rather than how it fits into their overall plan. That’s like choosing kitchen appliances before designing the house.”
“Understanding personal financial goals and risk appetite is essential,” said Jordan Gilberti, CFP, founder of Sage Wealth Group. “Annuities can provide peace of mind, but they must fit within the broader context of one’s retirement plan.”
Are you looking for predictable income to cover core living expenses, or are you comfortable accepting some market risk in exchange for higher growth potential? This is often greatly informed by how an annuity fits in with your other retirement assets and income streams.
“Emotional risk tolerance also matters,” said Swad. “If someone historically sold out during events like the 2008 crisis or COVID volatility, that’s a sign they may need to assess how much fluctuation they can truly stomach before hitting the panic button.”
Payout Timing Needs
Income timing needs are also important to consider, as they’ll typically guide you toward either an immediate or deferred contract.
“Immediate annuities are best suited for clients who need guaranteed lifetime income now—especially if their essential expenses aren’t fully covered by existing sources, like Social Security or a pension,” said Swad.
Example
For example, if you need $5,000 per month in fixed income right away and only receive $3,000 from Social Security, you might use an immediate annuity to generate the remaining $2,000.
“Deferred income annuities that eventually convert to lifetime income (e.g., starting in 5–10 years), can also be used to lock in future income needs,” said Swad. For example, say you’re a decade out from retirement and your projected Social Security benefits fall short of your estimated living expenses in retirement. You might purchase a deferred annuity that starts paying out in a decade to make up for the expected shortfall.
Deferred annuities can also help address intermediate-term needs. “For instance,” said Swad, “if a client won’t begin Social Security for three years and needs $60,000 per year to bridge that gap, I may build a ladder using bonds and annuities that can serve that purpose. We could buy a one-year bond, a two-year bond, and a three-year fixed annuity, each with $60,000 in principal invested.”
Additional Considerations
Annuities allow for countless riders, opening up many other critical decisions. One of the most important is payment duration: whether you want to spread your annuity income over a set period or the rest of your life.
“Most income annuities I use are structured for lifetime income, which helps protect against longevity risk,” said Swad. “Some do offer shorter terms, but they’re less common and often not as beneficial for long-term retirement planning.”
Spousal coverage is another major consideration, as it determines what happens when you pass away. “Spousal coverage is critical in many cases,” said Swad. “If the surviving spouse would still need income, choosing a joint-life payout ensures the income continues for the remainder of both lives.”
Inflation protection is also worth considering, though it can be misunderstood. “While some annuities offer a fixed percentage increase each year (e.g., 2% or 3%), it’s usually not tied to the CPI or an actual inflation index,” said Swad. “These riders also often come with a significantly reduced initial payout.”
Pros and Cons of Annuities
The primary appeal of an annuity lies in its promise of stability. “In 2025, annuities are increasingly integral to retirement strategies for clients seeking predictable income,” said Gilberti. “With market fluctuations and economic uncertainties, annuities offer a sense of security that many retirees find appealing.”
Annuities are also highly customizable, allowing you to tailor their income streams to fill specific gaps in your retirement plan—whether that’s a long-term need for fixed income or a short-term bridge until you start drawing Social Security.
However, annuities also come with significant downsides, including non-transparent and restrictive fees—such as surrender charges—that can trap consumers. “While annuities offer stability, their complexity and potential penalties for early withdrawal necessitate a clear understanding,” said Gilberti.
If you can navigate their twists and turns, annuities can be beneficial—as long as you align them to your personal finances. “Annuities aren’t magic potions, but they’re not boogeymen either,” said Miu. “The right one, used the right way, can be a valuable piece of your financial picture.”
Can Annuities Be Adjusted for Inflation, and How Does That Affect Payouts?
Some annuities offer inflation protection, which typically increases your payments each year by a set percentage. However, these increases aren’t always tied to actual inflation rates, so your payments may not keep up with real-world price changes. Additionally, inflation protection isn’t free and may result in lower initial payouts or higher premiums.
What Happens to an Annuity if the Holder Passes Away?
When an annuity holder passes away, the insurer generally keeps any remaining value unless the contract includes a death benefit or a joint-life payout. When these features are present, the annuity may go to a beneficiary or the surviving spouse instead.
Are There Any Penalties for Withdrawing From an Annuity Early?
Most annuities impose steep surrender charges for early withdrawals, especially within the earlier years of the contract. However, these penalties often decrease over time. For example, they may start at 7% and drop by 1% each year until withdrawals become penalty-free.
The Bottom Line
Annuities can play a valuable role in your retirement strategy, offering stability, customizable income streams, and protection against longevity risk. However, their complexity, fees, and restrictions require careful consideration.
Before committing, take stock of your unique financial situation, including your income needs, risk tolerance, and goals. When you’re ready to start comparing options, a qualified financial advisor can help you understand contract terms and ensure the annuity you choose complements the rest of your retirement plan.
