Annuities are financial contracts offered by insurance companies designed to provide steady income—often in retirement—while helping protect against the risk of outliving one’s savings. They can seem complex at first because of the different types, rules, fees, and guarantees involved. Getting a solid understanding early can help you decide whether an annuity makes sense for your financial goals.

For someone embarking on retirement planning, it helps to know how annuities work, what options exist, how income is generated, and what to watch out for. This guide aims to explain in plain, balanced terms what annuities are, how they differ, their pros and cons, and how to evaluate whether one might be right for you. It does not make guarantees or investment advice, only objective information to support your decision-making.

Understanding What an Annuity Is

An annuity is a contract between you and an insurance company where you pay either a lump sum or a series of payments, and in return the insurer promises to make income payments to you now or in the future. Often the future payments are designed to begin in your retirement and continue for a fixed period or for the rest of your life. There are different phases of an annuity contract: accumulation (when your money is growing) and payout (when you receive payments). The insurance company may offer guarantees such as minimum interest or income for life. (NAIC, 2025, Insurance Topics Annuities, https://content.naic.org/insurance-topics/annuities

Annuities are neither banks nor direct investments like stocks; they are insurance products subject to insurance laws, which often include surrender periods, fees, and tax deferral. Understanding all terms—when payments start, how gains are credited, what guarantees are included—is essential. Your specific contract will determine how flexible or restrictive your annuity is.

The Main Types of Annuities

• Fixed annuities: These guarantee a minimum interest rate, providing predictable growth during the accumulation phase, and stable payout amounts during the income phase. They tend to be low risk but also offer lower potential returns compared with more market-linked options.
• Variable annuities: In these, your money is invested in subaccounts (similar to mutual funds), so returns may be higher—but you also assume more risk. Variable annuities may include riders (extra features at extra cost) for guaranteed minimum income or protection against market downturns.
• Indexed annuities: Sometimes called fixed indexed annuities, these offer a blend: your credited returns are tied to an external market index (for example, an equity index), but typically include floors and caps which limit both downside and upside. They provide some growth potential while offering downside protection.
• Immediate vs Deferred: Immediate annuities begin income payments within a year of purchase; deferred annuities allow your money to accumulate first and income payments to begin at a later date (often at retirement). Each has trade-offs in timing, growth, and flexibility.

These types differ in risk, return, fees, liquidity, and guarantees. For example, fixed annuities are more conservative, variable ones have higher risk and potential reward, and indexed annuities fall somewhere in between. The choice depends on how much risk you’re comfortable with, whether you need income now or later, and what guarantees you require.

How Annuities Provide Income

To understand how annuities turn into income, here is one recent quantitative snapshot: U.S. annuity sales in 2024 reached $432.4 billion, up 12 percent over 2023, showing strong interest in locking in guaranteed income. (LIMRA, 2025, 2024 Annuity Insights Report, https://icapital.com/insights/annuities/2024-annuity-insights-report/

The process begins with accumulation: you pay premiums (either all at once or over time), and depending on the annuity type, your funds grow either via guaranteed rates, market performance, or index links. When you annuitize (choose to begin income payments) or select income options (immediate payment, deferred, lifetime payments, etc.), the insurer uses actuarial tables, interest rates, and your life expectancy to calculate payments. Some annuities also allow for joint-life payouts for couples or feature inflation adjustments, though those typically cost more.

Benefits and Drawbacks of Annuities

Benefits

• Guaranteed income: Annuities can provide steady, predictable income that can last for life, helping reduce the risk of outliving your savings.
• Tax deferral: Earnings grow tax-deferred until you withdraw, potentially allowing your money to compound faster than in taxable investment accounts.
• Protection: Certain annuities include features (guarantees, floor interest rates) that protect your principal or income during market declines.

Drawbacks

• Fees and expenses: Surrender charges, commissions, insurance fees, and costs for riders can reduce your net return.
• Liquidity constraints: Many annuities restrict access to funds for a period or impose penalties for early withdrawal; you may not be able to access money easily in emergencies.
• Complexity: Different types, riders, caps, participation rates, and conditions can make contracts hard to compare. Also inflation risk: if your income is fixed and inflation rises, the real value of payments can erode.

Examining both sides helps ensure realistic expectations: annuities are not “one size fits all,” and what works well for one person may not for another depending on need, timeline, risk tolerance, and other income sources.

Deciding If an Annuity Is Right for You

Here are key questions to ask before you commit to an annuity contract:

• What are your income needs now and in the future (how much monthly/annual income do you anticipate needing)?
• Do you value guarantees (lifetime payments, minimum interest) more than having higher potential upside with risk?
• What is your health, life expectancy, and family situation (are there beneficiaries, spousal needs, etc.)?
• How will the fees, surrender period, riders, and liquidity constraints impact you?
• How do annuity payments interact with other income sources (Social Security, pensions, savings)?

You should compare multiple providers and quotes to see what rates and options are available, and check regulatory protections in your state. Working with an adviser who must act in your best interest (as required by NAIC Best Interest standards now adopted in all 50 states) helps ensure the product is suitable for your situation. (NAIC, 2025, Suitability in Annuity Transactions Model Regulation, https://content.naic.org/insurance-topics/annuity-suitability-%26-best-interest-standard

Making Annuities Part of a Balanced Retirement Plan

Annuities can play an important role in helping retirees create reliable income streams, manage longevity risk, and build stability into their financial plan. They provide a level of certainty that can complement other retirement income sources such as Social Security, pensions, and investment accounts. For many people, the appeal lies in knowing that a portion of their income will continue regardless of market conditions.

At the same time, annuities are not a one-size-fits-all solution. The variety of products, features, and costs means that due diligence is essential. Evaluating how an annuity aligns with your goals, time horizon, and other assets is the best way to decide if it belongs in your plan. Taking the time to review the options with a trusted adviser can help you move forward with confidence, knowing your decision fits within your broader retirement strategy.