What is an Annuity?
An annuity is a contract between you and an insurance company. You give them a lump sum (or series of payments), and they promise to pay you a regular income — either immediately or starting at a future date — for a set period or for the rest of your life. The primary appeal is certainty: you can't outlive the income stream.
Annuities are not investment accounts. They're insurance products, and you're paying for the guarantee. Whether that trade-off makes sense depends heavily on your situation, other assets, and what rate you're offered.
Types of Annuities
The main distinctions are when payments start and how the money grows:
- Immediate annuity (SPIA): You pay a lump sum today and start receiving payments within a month. Simple, transparent, and useful if you need income now.
- Deferred annuity: Payments start at a future date. The accumulation phase can be fixed rate, variable (tied to sub-accounts), or indexed (tied to a stock index with a floor).
- Fixed annuity: Earns a guaranteed interest rate during accumulation. Predictable but may lag inflation.
- Variable annuity: Invested in market sub-accounts. Higher potential growth, but your payout can fall if markets drop. Usually comes with higher fees.
- Fixed-indexed annuity (FIA): Credits based on index performance (like the S&P 500), usually with a cap and a floor of 0% — you don't lose principal, but gains are limited.
How Annuity Payments Are Calculated
For a simple immediate annuity, the payout rate depends on your age, the interest rate environment, and the payout option you select. The insurer uses actuarial tables to estimate how long you'll live and prices accordingly.
Common payout options:
- Life only: Highest monthly payment, but stops when you die — even if that's next month.
- Life with period certain (10 or 20 years): If you die early, payments continue to beneficiaries for the remaining period.
- Joint and survivor: Covers two people (usually spouses). Payments continue to the survivor at 50%, 75%, or 100% of the original amount.
As a rough benchmark: a 65-year-old investing $100,000 in a SPIA might receive around $560–$620/month for life (rates vary with interest rates and insurer).
When Annuities Make Sense (and When They Don't)
Consider an annuity if: You lack a pension, you're worried about outliving savings, you want guaranteed income to cover basic expenses alongside Social Security, or you're in good health with longevity in your family.
Skip or wait if: You have significant other guaranteed income (pension + Social Security), you're in poor health, you need liquidity, or the fees on a variable or indexed annuity seem high relative to the guarantee. Surrender charges — typically 7–10% in year one, declining over 7–10 years — make early exit costly.
Frequently Asked Questions
Is annuity income taxable?
It depends on how you funded it. If you used pre-tax money (e.g., from a Traditional IRA or 401(k)), all payments are taxable as ordinary income. If you used after-tax money, only the earnings portion of each payment is taxable — the rest is a return of your own contribution (the "exclusion ratio").
What happens to my annuity if the insurance company fails?
State guaranty associations protect annuity owners up to certain limits — typically $250,000 per insurer per state, though it varies. Buying from a financially strong insurer (check AM Best ratings) reduces this risk. Spreading large sums across multiple insurers is an option for very large annuity purchases.
Can I cancel an annuity after buying it?
Most annuities have a "free look" period — typically 10–30 days — during which you can cancel for a full refund. After that, surrender charges apply, starting high (often 7–10%) and declining over 7–10 years. Check the surrender schedule carefully before buying.
What's the difference between annuity and life insurance?
Life insurance pays out when you die; an annuity pays out while you live. Both are insurance products that deal with longevity risk, just from opposite directions. Some products (variable universal life, indexed universal life) combine features of both, though they can be complex and fee-heavy.
Is this calculator for immediate or deferred annuities?
This calculator handles both. Enter a lump sum and start date to model an immediate annuity, or enter a deferral period and accumulation rate to model a deferred annuity. The payout phase uses standard present value of annuity formulas.