Annuity

An annuity is a financial contract between a person and an insurance company. The person makes either a lump-sum payment or a series of payments to the insurance company. In return, the insurance company promises to send back regular payments, either starting right away or at some point in the future. Annuities are commonly used as a way to create steady income during retirement.

There are several main types of annuities:

• Fixed annuity: Pays a set amount on a regular schedule. The payment amount does not change, which makes budgeting easier.
• Variable annuity: Payments can go up or down depending on how the underlying investments perform. This type carries more risk but also more potential for growth.
• Indexed annuity: Returns are tied to a market index, like the S&P 500, but usually include a floor that limits how much you can lose.
• Immediate annuity: Payments begin very soon after a lump sum is paid, often within 30 days.
• Deferred annuity: Money grows over time and payments begin at a future date, often at retirement.

A practical example: A 65-year-old retiree hands an insurance company $200,000. In return, the insurance company agrees to pay $1,100 per month for the rest of that person’s life. This arrangement helps protect against the risk of outliving personal savings, a concept sometimes called longevity risk.

Annuities grow on a tax-deferred basis, meaning taxes on earnings are not paid until withdrawals begin. Withdrawals taken before age 59 and a half may trigger a 10 percent IRS early withdrawal penalty in addition to regular income taxes. In 2026, there are no IRS contribution limits specific to non-qualified annuities, but annuities held inside qualified accounts like IRAs are subject to those account contribution rules.

Annuities often come with fees such as surrender charges, mortality and expense fees, and administrative costs. These fees can reduce overall returns, so it is important to read any contract carefully before signing.

RetireGrader is not a financial advisor or fiduciary. This definition is for educational purposes only. Consulting a licensed insurance or financial professional is a helpful step before purchasing any annuity product.