What are annuities and how do they work?
They are commonly associated with retirement planning due to their ability to provide reliable payments over time


Annuities are a financial product commonly associated with retirement planning due to their ability to provide reliable payments over time. But lately, thanks in large part to their potentially higher yields and tax advantages, annuities are starting to gain more widespread popularity — even among younger investors.
In particular, fixed-rate deferred annuities — "which resemble certificates of deposit, but offer higher yields on average thanks to the broad portfolio of investments insurance companies hold" — are "booming," said The Wall Street Journal, probably due to "the Federal Reserve's rate increases beginning in 2022." But even as the Fed has started to cut rates, "sales show little sign of slowing," the outlet added.
Before you consider hopping onboard this new trend, it is important to understand exactly how annuities, a notoriously complex financial vehicle, actually work.
The Week
Escape your echo chamber. Get the facts behind the news, plus analysis from multiple perspectives.

Sign up for The Week's Free Newsletters
From our morning news briefing to a weekly Good News Newsletter, get the best of The Week delivered directly to your inbox.
From our morning news briefing to a weekly Good News Newsletter, get the best of The Week delivered directly to your inbox.
What is an annuity?
"An annuity is a contract with an insurance company that provides a stream of income, typically in retirement, in exchange for money paid into the annuity," said Bankrate. To buy an annuity, you either pay a lump sum or make a series of payments over time, and in return, you will receive payments, either all at once or at regular intervals.
These payments can begin immediately, but in general they are "deferred — meaning you have to leave the money untouched for a number of years or face stiff penalties," said CNBC Select. The amount of the payments you receive typically depends on how much you pay in.
How do different types of annuities work?
The specifics of how an annuity works depends on the type of annuity it is. Here is an overview of some of the main types:
Immediate annuities: As the name suggests, an immediate annuity "starts providing income payouts right after you make your initial lump sum investment," said CBS News.
A free daily email with the biggest news stories of the day – and the best features from TheWeek.com
Deferred annuities: A deferred annuity "is designed to grow on a tax-deferred basis, providing guaranteed income to the annuitant starting on a particular date they choose," said Kiplinger.
Fixed annuities: With a fixed annuity, an "insurance company promises you a set rate of interest that is locked in rather than being tied to market rates," said Credit Karma. A fixed annuity can be immediate or deferred.
Variable annuities: Variable annuities "allow the owner to receive larger future payments if investments held in the annuity fund do well or smaller payments if its investments do poorly," said Investopedia.
Indexed annuities: An indexed annuity "offers a rate of return that tracks an index such as the S&P 500," said Bankrate.
What are the pros and cons of annuities?
Annuities can offer definite benefits, depending on the type you purchase. These include:
Reliable stream of income. "With most types of annuities, especially fixed annuities, you are guaranteed to receive a specified income payment amount on a regular schedule," said CBS News. Some annuities can even offer payouts "for as long as you live."
Tax advantages. "Qualified annuities offer tax-deferred growth on your investment until you withdraw the money or begin receiving payments," said Bankrate, which is helpful when saving for retirement.
No contribution or other limits. "Unlike an IRA or 401(k), an annuity doesn’t require annual contribution limits," said Kiplinger, plus there is "no limit on the amount of annuities you can have."
On the other hand, it is important to weigh the following drawbacks of annuities as well:
Complexity. Annuities are not a straightforward financial product, with contracts "often totalling dozens of pages" and varying "markedly from one to the next," said Bankrate.
Fees and commissions. It is possible that annuities can have "fees, such as surrender charges, mortality and expense risk fees, sales and commissions and administration fees," said Kiplinger, which eat into your returns.
Lack of liquidity. Though you will "receive your income stream, and may be able to withdraw some of the principal," said Bankrate, "for the most part, your money is locked into the annuity and you have relatively little access to it."
Possible caps on returns. While "your annuity may be guaranteed not to lose money," it is possible that "providers put a cap on the interest rate you can earn," said CNBC Select.
Becca Stanek has worked as an editor and writer in the personal finance space since 2017. She previously served as a deputy editor and later a managing editor overseeing investing and savings content at LendingTree and as an editor at the financial startup SmartAsset, where she focused on retirement- and financial-adviser-related content. Before that, Becca was a staff writer at The Week, primarily contributing to Speed Reads.
-
‘Tariffs at their essence are an income transfer’
Instant Opinion Opinion, comment and editorials of the day
-
Why is Trump backtracking on the Hyundai immigration raid?
Today’s Big Question Backlash threatens investment in US manufacturing
-
The 9 restaurants to eat at this very moment
The Week Recommends They’re award-winning. Isn’t that reason enough?
-
How to put student loan payments on pause
The Explainer If you are starting to worry about missing payments, deferment and forbearance can help
-
The pros and cons of buying a new-build house
the explainer Repairs and maintenance will be minimal on a brand new build — but moving into an existing home can be easier upfront
-
What's the best time of year to buy a house?
The Explainer There are pros and cons to each season
-
How much does it cost to move? Here's how to budget and save.
the explainer Factors like move distance and the weight of your furnishings can affect the total cost — but there are several ways to economize
-
When does a personal loan make sense?
the explainer Personal loans tend to be more flexible and versatile than home, auto or student loans
-
Should you downsize for retirement? Here's what to consider.
The Explainer Moving to a smaller place may seem easier, but there are also some real benefits to staying put
-
What to do if you want to move but don't want to give up your low mortgage rate
the explainer 30-year mortgage rates are currently averaging 7% — and homeowners who secured rates closer to 3% during the pandemic are reluctant to sell their homes
-
Is hands-off investing the way to go?
The Explainer In many cases, your money might be better off left alone