Why it matters
- An annuity can provide steady income that may help protect you from outliving your retirement savings.
- Unlike 401(k)s and IRAs, annuities don't have contribution limits, but they typically do offer tax-deferred growth on your investments.
- You can customize annuities to fit your individual needs, like having payments that rise with inflation or helping ensure you leave a legacy for oved ones.
When planning for retirement, the goal is to make sure you’re saving enough to fund the lifestyle you want. If an annuity product isn’t part of your retirement plan, you may be surprised by some of their key features. Annuities offer the opportunity to receive stable, guaranteed income throughout your retirement, while enjoying tax-deferred growth and the ability to leave a legacy.1 They can also be a good way to address the risk of potentially outliving your savings.2 In 2024, retirement annuity assets totaled $2.5 trillion.3 Read on to understand how annuities work, learn about the different types of annuities, and determine if an annuity has a place in your retirement portfolio.
What are retirement annuities and how do they work?
An annuity is a long-term insurance contract. They typically involve just two parties, but they can include as many as four — the issuer (usually an insurance company), the owner of the annuity, the annuitant (often the same person as the owner), and a beneficiary.4
Here’s how an annuity generally works: You agree to pay an insurance company a lump sum or a series of premium payments. Based on the claims-paying ability of the insurance company, when you retire, the insurance company pays you out at regular intervals, usually until your passing. You can receive payments as an income stream for a set number of years or even the rest of your life. There are different types of annuities and several ways to classify them, including immediate or deferred, and fixed or variable. We’ll touch on their differences a little later on.
An annuity’s lifecycle includes two main phases: accumulation and payout. The accumulation phase is the period when an annuity is funded — either in one lump sum or via a series of smaller payments — and before payouts begin. During the accumulation phase, money invested in the annuity grows on a tax-deferred basis. The payout phase begins once money starts to be paid out from the annuity.2
Variable annuities are sold with a prospectus and regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulation Authority (FINRA). Agents selling annuities must have a state-issued license, as well as a securities license if they sell variable annuities.2
The benefits of annuities
Annuities can be an important part of your retirement planning. Similar to individual retirement accounts such as (IRAs) and 401(k)s, money that’s invested into an annuity will grow tax-deferred, and it won’t be subject to capital gains taxes.5 Unlike IRAs and 401(k)s, there’s no limit to the amount you can contribute to an annuity, making it a potentially good choice if you’ve already maxed out what you can contribute to your retirement accounts for the year. However, your payouts (distributions) are taxed just like regular income, and surrender charges may apply.
Income
Annuities are generally designed to provide a steady, reliable income stream during retirement. They can help create confidence by knowing that you’ll have the money you need throughout your retirement.2 Withdrawals of taxable amounts are subject to ordinary income tax and may be subject to a 10% additional tax if withdrawn before age 59 ½.
Legacy
As the owner of the annuity, you’ll be able to designate a beneficiary to inherit your investment.4 This allows you to leave a legacy and ensure your loved ones are provided for in the future.
Customize your annuity with riders
Annuity contracts can be designed with a number of riders—which are usually available for an additional fee—letting you customize the annuity according to your needs.8 For example, riders can let you designate a specific beneficiary for your annuity or have your payout adjust with inflation. The guaranteed lifetime withdrawal benefit is a common rider. It lets you withdraw a certain percentage of the principal each year until you’ve withdrawn the full amount — a helpful hedge against the potential of running out of money in retirement.9,2 When designing your annuity, think about where it fits into your retirement portfolio.
The different types of annuities
Most annuities include some basic contract fees and surrender charges or a schedule of early withdrawal penalties. Typically, annuity contracts fall into one of three categories: variable, indexed, and fixed.1 The differences in these annuities determine how your annuity will grow.
Variable annuities
The value of a variable annuity changes based on the performance of an underlying portfolio of sub accounts that you select. Variable annuities give the possibility of increased returns during the accumulation phase. However, with greater returns comes the possibility of greater losses, making them riskier than fixed annuities.10 Variable annuities are subject to investment risks, including possible loss of principal. If you’re looking for growth potential linked to a market index, a variable annuity may be worth considering. Variable annuities typically include Mortality, Expense, and Administrative (ME&A) fees. Be sure to review the prospectus carefully for details on these and other charges.
Indexed annuities
While a variable annuity bases its interest rate on a portfolio, an indexed annuity pays interest based on how a certain stock market index, like the S&P 500, performs. You’ll hear indexed annuities sometimes called equity-indexed or fixed-indexed annuities.11 An indexed annuity might be a good fit for you if you want some protection from investment loss, but don’t mind potentially limited growth opportunities.
Fixed annuities
Fixed annuities pay out based on a specific, guaranteed interest rate. Due to their fixed nature, they offer lower risk than variable annuities, but they lack the potential for high growth that a variable annuity brings.12 Fixed annuities are generally best for those seeking a predictable income stream.
Investment protection
Some annuities are designed with floors and caps on their interest rates.6,7 Floors protect annuity owners from downturns in current rates and guarantee a set interest rate will be credited to the investment funds of a fixed or indexed annuity.6 A cap is an interest rate that limits the growth of an indexed annuity.7 Caps ensure the annuity provider can meet their obligations to the annuitant and still make a profit on the annuity.
Immediate vs. deferred annuities
Immediate annuities begin paying out as soon as they’re funded, usually meaning you deposit a lump sum into them. These annuities can be purchased by people of any age, and they’re often used when someone receives a large sum of money as a result of a settlement or lottery win. Deferred annuities begin paying out when you reach the age of your choice. The advantage with deferred annuities is that your investment has time to grow tax-free while you wait for the payouts to begin.2
Qualified vs non-qualified annuities for retirement
You can purchase an annuity with either pre-tax or after-tax dollars. A non-qualified annuity is purchased with after-tax dollars, while a qualified annuity is purchased with pre-tax dollars. Only the earnings of a non-qualified annuity are taxed at the time of withdrawal, not the contributions, since those were made with after-tax dollars.2 Non-qualified annuities can be a good option if you’ve already maxed out your employer-sponsored retirement plan contributions or if you don’t have an employer-sponsored plan and want to let your money grow in a tax-deferred account. A qualified annuity effectively reduces your income, and taxes owed, for the year in which you make the contribution.
An annuity can be a smart addition to your retirement portfolio, especially as you get closer to retirement or if you’re more concerned about the risk of outlasting your savings.2 Since annuities can be structured in a variety of ways — variable, indexed, or fixed; qualified, or non-qualified — and can be personalized with riders, finding one that meets your specific needs and goals shouldn’t be difficult. As always, consult a financial professional for help designing the annuity product that’s best for you.
Things to consider
- Think about how much guaranteed income you want in retirement. This will help you determine if an annuity makes sense for your situation and how much you might want to invest.
- Review your current retirement accounts, such as your 401(k) and/or IRA, to see if you’ve maxed out your contributions and could benefit from an annuity’s unlimited contributions feature.
- Schedule a meeting with a financial professional who can explain which type of annuity could best match your financial goals and risk tolerance.
Transamerica Resources, Inc. is an Aegon company and is affiliated with various companies which include, but are not limited to, insurance companies and broker dealers. Transamerica Resources, Inc. does not offer insurance products or securities. The information provided is for educational purposes only and should not be construed as insurance, securities, ERISA, tax, investment, legal, medical or financial advice or guidance. Please consult your personal independent professionals for answers to your specific questions.
1 “Annuities,” Investor.gov, accessed February 2025
2 “Guide to Annuities: What They Are, Types, and How They Work,” Investopedia, September 2024
3 “Retirement Assets Total $42.4 Trillion in Third Quarter 2024,” Investment Company Institute, December 2024
4 “Annuity Contract: What It Means and How It Works,” Investopedia, June 2024
5 “How Are Annuity Withdrawals Taxed?” Kiplinger, October 2024
6 “Interest Rate Floors,” Annuity.org, accessed February 2025
7 “Rate Caps,” Annuity.org, accessed February 2025
8 “Annuity Riders & Contract Provisions,” Annuity.org, accessed February 2025
9 “Guaranteed Lifetime Withdrawal Benefit,” Annuity.org, accessed February 2025
10 “Variable Annuity: Definition, How It Works, and vs. Fixed Annuity,” Investopedia, October 2024
11 “Indexed Annuity: Definition, How It Works, Yields, and Caps,” Investopedia, July 2024
12 “What Is a Fixed Annuity? Uses In Investing, Pros, and Cons,” Investopedia, November 2024
