Annuities Explained: Immediate, Deferred, Fixed, Variable, and Indexed

An annuity is a contract with an insurance company. You pay money in, either all at once or over time, and the insurer promises payments back, either as a stream of income or as a value that grows. Some annuities are simple and inexpensive. Others are complex, with layers of fees and features that are hard to compare. The word "annuity" covers all of them, which is why opinions about annuities vary so much.

The short version

• Immediate annuities convert a lump sum into income that starts right away, often for life.
• Deferred annuities grow first and can be turned into income later.
• Fixed annuities credit a rate set by the insurer.
• Variable annuities invest in sub-accounts and can lose value; they're securities.
• Indexed annuities credit interest linked to a market index, subject to caps and other limits, with protection from index losses.
• Growth inside annuities is generally tax-deferred, but withdrawals of earnings are taxed as ordinary income, and withdrawals before a certain age may face a tax penalty.
• Surrender charges, rider fees, and other costs can be significant. Guarantees depend on the insurer's ability to pay.

The main types

Income annuities: buying a paycheck

An immediate or deferred income annuity converts savings into guaranteed income. Its main strength is longevity protection: lifetime payments continue no matter how long you live. Its main trade-off is liquidity: you generally can't get the lump sum back. Payout rates depend on age, sex, interest rates, and the options you choose, such as a joint life payout or a guaranteed period.

Income annuities address the same risk discussed in our guides on pension lump sum vs. annuity and sequence-of-returns risk.

Deferred annuities and tax deferral

Earnings inside a deferred annuity generally aren't taxed until withdrawn. A hypothetical comparison: $100,000 earning 4.5% a year, taxed at 24% either annually (like a taxable CD) or only at withdrawal (like a deferred annuity), ignoring fees:

Tax deferral helps more over longer periods. But it can be outweighed by annuity fees, and withdrawals of earnings are taxed as ordinary income rather than at potentially lower capital gains rates. Early withdrawals before a certain age can also face a federal tax penalty in addition to income tax, with exceptions. Holding an annuity inside an IRA adds no extra tax deferral.

Surrender charges

Most deferred annuities charge a fee if you withdraw more than an allowed amount during the early years of the contract. A common structure declines over time:

Many contracts allow a free withdrawal, often around 10% of the value per year, without a surrender charge. Some include a market value adjustment that can raise or lower what you receive on surrender based on interest rate changes. The contract's disclosure lays out the exact schedule.

Fees to understand

• Mortality and expense charges and administrative fees on variable annuities.
• Sub-account expenses inside variable annuities.
• Rider fees for optional guarantees, such as guaranteed lifetime withdrawal benefits.
• Caps, participation rates, and spreads on indexed annuities, which limit credited interest rather than charging an explicit fee.
• Surrender charges for early withdrawals.

Compare all-in costs, and ask what each feature costs separately.

Guarantees depend on the insurer

Annuity guarantees are backed by the issuing insurer's claims-paying ability. State guaranty associations provide some protection up to limits if an insurer fails; limits vary by state. Insurer financial strength ratings are one way to assess this.

Questions to ask before buying

1. What problem is this annuity solving: lifetime income, safe growth, or something else?
2. What are all the fees, including riders?
3. What's the surrender charge schedule and free withdrawal amount?
4. How exactly is interest credited, and what are the caps or participation rates? Can they change?
5. What happens at death? Who receives what?
6. What's the insurer's financial strength?
7. How is the person recommending it paid?

There's a "free look" period after purchase during which you can typically cancel for a refund; see free-look periods.

The takeaway

Annuities range from simple, low-cost income contracts to complex products with multiple fees and conditional guarantees. Immediate and deferred income annuities can provide lifetime income; deferred fixed annuities can provide tax-deferred, guaranteed growth. Understand the type, the fees, the surrender schedule, and the insurer behind it before buying, and compare with alternatives.