Annuities Explained: 10 Questions You Should Answer Before You Buy One

Annuities may be among the most misunderstood financial products in retirement protection planning.

Ask one person about annuities and you may hear:

• "Your money is locked up."
• "Insurance companies keep everything when you die."
• "They're loaded with fees."
• "You can't lose money."
• "They guarantee income for life."

Every one of those statements can be true in a particular situation, and misleading in another.

The problem is that "annuity" is not one product.

A fixed annuity does not work like a variable annuity. A fixed indexed annuity does not work like a RILA. A MYGA designed to accumulate interest is fundamentally different from an immediate annuity designed to convert a lump sum into lifetime income.

The National Association of Insurance Commissioners describes an annuity as an insurance contract sold by a life insurance company. Annuities may be immediate or deferred, and their values may be fixed, variable, or linked to an external index.

So before deciding whether an annuity is good, bad, expensive, safe, liquid, or worth owning, you need to know which annuity you are talking about and what financial problem it is supposed to solve.

Here are ten questions every consumer should understand.

1. What Actually Happens to Your Money When You Buy an Annuity?

When you purchase an annuity, you enter into a contract with an insurance company.

You provide the insurer with money, called a premium or purchase payment, and the insurer accepts contractual obligations in return.

Those obligations might include:

• crediting a guaranteed rate of interest,
• crediting interest according to an index formula,
• allowing investment in variable subaccounts,
• guaranteeing a future withdrawal amount,
• providing a death benefit, or
• promising to make income payments for as long as you live.

What actually happens behind the scenes depends on the type of annuity.

With a fixed annuity or MYGA

The insurer is responsible for providing the contractual guarantees.

Economically, you are not buying a personal portfolio of bonds that sits in an account with your name on it. You own an insurance contract. The insurer manages assets supporting its obligations and promises to credit your contract according to the terms of that contract.

That distinction is important.

If you put $100,000 into a five-year MYGA paying a guaranteed contractual rate, your return does not depend directly on whether the particular bonds or other assets held by the insurer rise or fall in market value.

Your claim is against the insurance company under the annuity contract. That is why the insurer's financial strength matters.

With a fixed indexed annuity

You still do not directly own the S&P 500, Nasdaq-100, or whichever index may be referenced. Instead, the insurance company uses the performance of an external index as one component of a crediting formula.

Your credited interest might be determined by:

• a cap,
• participation rate,
• spread,
• trigger rate,
• declared rate, or
• another contractual method.

For example, if an index rises 12%, that does not necessarily mean your annuity receives 12%. If the strategy has an 8% cap, the credited interest might be limited to 8%, subject to the exact contract terms.

FINRA specifically notes that indexed-annuity returns are based on external indexes but generally do not provide the full positive return of the index.

And importantly: you do not receive the index's dividends merely because the annuity references that index. The index is part of the calculation. You are not directly invested in the stocks that make up the index.

With a variable annuity

The structure is different.

Your purchase payments can generally be allocated among investment options called subaccounts, which often invest in underlying stock, bond, or other investment funds. These investments are typically held through a legally segregated insurance-company separate account. The value can rise or fall with investment performance.

The NAIC explains that variable-annuity contributions can be allocated to subaccounts within a separate account and that the policyholder bears investment risk associated with those selections.

So if someone tells you, "The insurance company invests all annuity money the same way," that is incorrect. The actual structure depends heavily on the type of annuity.

2. Are Annuities Actually Worth It?

Sometimes. The answer depends less on whether annuities are "good investments" and more on what risk you are trying to transfer.

Annuities can potentially address several problems:

Longevity risk. What happens if you live to 95 or 100? A properly structured lifetime-income annuity can continue paying even if you live far longer than expected.

Sequence-of-returns risk. A severe market decline immediately after retirement can be especially damaging when you must simultaneously withdraw money to live. Guaranteed income from an annuity may reduce the amount that needs to be withdrawn from investment accounts during difficult markets.

Principal stability. Some consumers are willing to sacrifice market upside in exchange for greater predictability.

Income uncertainty. Some retirees simply prefer knowing that a portion of their monthly spending is contractually covered.

That is where an annuity can become useful. But the guarantees come at a price. You may give up some combination of:

• liquidity,
• upside potential,
• flexibility,
• simplicity,
• control over principal, or
• legacy value.

That means an annuity should not be evaluated simply by asking, "What return can I make?"

Instead ask: What risk is this contract transferring from me to the insurance company, and is that guarantee worth what I am giving up?

An annuity may be worth considering when:

• predictable lifetime income is important,
• you are worried about outliving your money,
• you want to reduce exposure to certain market risks,
• you already have adequate emergency liquidity elsewhere,
• the contractual guarantees directly solve a retirement-planning problem,
• you understand the restrictions, and
• the insurer is financially strong.

An annuity may be less attractive when:

• you need substantial access to the money,
• your primary objective is maximum long-term growth,
• you already have enough guaranteed pension and Social Security income,
• you have a short time horizon,
• you do not need the insurance guarantee,
• the product is too complex to understand, or
• a simpler alternative accomplishes the same objective more efficiently.

Annuities are therefore neither inherently good nor inherently bad. They are risk-transfer contracts. The question is whether you need the risk transfer.

3. How Much Monthly Income Can $100,000 Buy You?

There is no universal answer.

Anyone who says "$100,000 gets you $700 per month for life" without providing additional information is leaving out important variables.

Lifetime annuity income can depend on:

• your age,
• when payments begin,
• sex where permitted and applicable to pricing,
• prevailing interest rates,
• the insurance company,
• your state,
• single-life versus joint-life income,
• period-certain guarantees,
• cash-refund provisions,
• inflation adjustments, and
• other contractual features.

A real 2026 example

Marketplace data surveyed on August 5, 2026 showed the following illustrative immediate-annuity payments for a $100,000 premium at age 65:

These were illustrative marketplace figures and excluded state-specific premium taxes. Actual rates change and require an individualized quote.

Notice what happens. Adding protection for beneficiaries generally reduces the monthly income.

Why? Because with a pure life-only contract, the insurer's obligation can end when the annuitant dies. With a cash refund or guaranteed payment period, the insurer may have to continue providing value after an early death. More guarantees generally mean a smaller monthly check.

Do not confuse payout rate with investment return

Suppose an annuity pays $679 per month. That equals $8,148 per year. On a $100,000 premium, the initial annual payout is approximately 8.15%.

But that does not mean the annuity is "earning 8.15% interest."

Your payments can consist of several economic components, including a return of your original premium, interest, and the effects of mortality pooling. This is one of the most important concepts in understanding income annuities: a payout rate is not the same thing as an investment yield.

If you deposit $100,000 into a bank account earning 8.15%, you still own your $100,000. If you exchange $100,000 for a life-only immediate annuity, you have generally converted that lump sum into a contractual stream of income. Those are very different economic arrangements.

4. Can You Actually Lose Money in an Annuity?

Yes. But how you can lose money depends on the annuity. This is another reason the statement "annuities cannot lose money" is inaccurate.

Fixed annuity or MYGA

With a traditional fixed annuity, ordinary stock-market declines do not directly reduce your contract value. But that does not eliminate every way you can lose economically. You could potentially lose value because of:

• surrender charges,
• a market value adjustment if the contract includes one,
• withdrawing more than permitted,
• inflation eroding purchasing power,
• insurer insolvency beyond applicable protections, or
• opportunity cost if interest rates or other investments become substantially more attractive.

So: no direct stock-market loss does not mean no risk.

Fixed indexed annuity

A properly structured traditional fixed indexed annuity generally provides contractual protection against a negative index-crediting result during a completed crediting period, subject to the contract. If the index falls substantially, the indexed strategy may simply receive no interest for that period rather than experiencing the index's full loss.

However, your contract value can still potentially be affected by surrender charges, market value adjustments where applicable, rider charges, withdrawals, or insurer financial difficulty.

Variable annuity

Yes, you can absolutely lose money. Variable-annuity subaccounts are exposed to market performance. Investor.gov states plainly that the value of a variable annuity changes according to the investment options selected, fees, and market performance. If the underlying investments fall, your account value can fall.

Certain guarantees may protect particular death benefits, withdrawal benefits, or income benefits, but those protections are not necessarily the same as guaranteeing your account value.

RILA

A Registered Index-Linked Annuity can also lose money. RILAs commonly use a buffer or floor to define how losses are shared.

For example, imagine a RILA with a 10% buffer. If the referenced index falls 8%, the buffer may absorb the entire decline. If the index falls 25%, the contract may absorb the first 10 percentage points while you absorb the remaining 15 percentage points, assuming that is how the particular segment is structured.

FINRA specifically notes that RILA owners can experience losses and explains the distinction between buffer and floor structures. A RILA should therefore never be described as a product where "you cannot lose money."

5. What Happens if the Insurance Company Goes Bankrupt?

This is a critical question because annuity guarantees are only as meaningful as the institution standing behind them.

Annuities are not FDIC insured. They are also not protected by SIPC simply because they are used for retirement purposes. FINRA states that annuities are not guaranteed by the FDIC, SIPC, or another federal agency.

So what happens if an insurer fails?

First, insurance companies are regulated for solvency. Insurance companies are subject to state solvency regulation, reserve requirements, capital requirements, financial reporting, examinations, and other regulatory oversight. If an insurer becomes financially distressed, state insurance regulators may place the company into rehabilitation or liquidation. The goal may be to preserve contracts, transfer policies to another insurer, restructure obligations, or use the failed insurer's remaining assets to satisfy claims.

Then state guaranty associations can become involved. Every state and the District of Columbia has a guaranty mechanism for covered insurance obligations, although the exact rules vary by jurisdiction.

These protections are not identical to FDIC insurance. Coverage:

• varies by state,
• has statutory limits,
• can exclude certain non-guaranteed portions,
• may depend on residency and insurer licensing,
• and should never substitute for evaluating the financial strength of the insurer.

NOLHGA's current state comparison shows that annuity protection is commonly $250,000 in present value of annuity benefits, although several jurisdictions provide $300,000 or $500,000 limits and special rules apply in certain states.

For example, if applicable state protection is $250,000 and someone has $400,000 of covered annuity benefits with an insolvent insurer, that does not necessarily mean the remaining $150,000 instantly disappears. Amounts above the guaranty-association limit may become claims against the failed insurer's remaining estate, but recovery is not necessarily guaranteed in full.

The practical lesson is simple: insurer selection matters. Do not choose an annuity solely because one insurer advertises the highest rate. Financial strength, diversification among carriers where appropriate, contract terms, and applicable state protections should also be evaluated.

6. Are Annuities Really Loaded With Fees?

Some are. Some are not. And some have fewer visible fees but still impose meaningful economic costs. That distinction is important.

Investor.gov separates annuity costs into explicit fees and implicit costs. It notes that many fixed annuities, fixed indexed annuities, and RILAs may not charge an explicit ongoing annual fee for the base contract, while limitations on credited returns can represent an implicit economic cost.

Fixed annuities and MYGAs

A straightforward fixed annuity or MYGA may have no annual management fee deducted from the account. But that does not mean "there are no costs." Potential costs include:

• surrender charges,
• market value adjustments,
• restricted liquidity,
• lower renewal rates after a guarantee period,
• and the spread between what the insurer earns and what it credits to the contract.

That spread is part of how the insurance company finances its guarantees and operations.

Fixed indexed annuities

Many FIAs also have no explicit annual fee on the basic accumulation strategy. Instead, part of the economic trade-off can appear through caps, spreads, participation rates, index formulas, and limited participation in market gains. Optional riders may carry explicit annual charges. A guaranteed lifetime withdrawal benefit, for example, may have an annual rider cost.

Variable annuities

This is where annuity fees can become much more visible. A variable annuity can potentially include:

• mortality and expense risk charges,
• administrative expenses,
• underlying fund expenses,
• surrender charges,
• enhanced death-benefit costs,
• lifetime-income rider charges,
• and other optional rider expenses.

Investor.gov warns that these fees directly reduce account value and investment return.

RILAs

RILA pricing varies substantially. Some contracts may have relatively low or no explicit annual base-contract fees, while economic costs are embedded in caps, participation rates, buffers, floors, index-crediting formulas, and optional benefit charges.

So the right question is not "Does this annuity have a fee?"

Ask: What is the total economic cost of this contract, both explicit and implicit, and what benefit am I receiving in exchange?

That is a much better comparison.

7. How Does the IRS Tax Annuity Income?

This depends heavily on what money was used to purchase the annuity and how the money comes out.

One of the biggest distinctions is between qualified annuities, held inside or purchased with qualified retirement assets such as an IRA or certain employer retirement plans, and nonqualified annuities, purchased with money that has already been subject to income tax.

The following discussion focuses primarily on federally taxed nonqualified commercial annuities. State taxation can differ.

Growth is tax-deferred

Generally, you do not currently pay federal income tax each year as interest or investment gains accumulate inside a nonqualified annuity. Taxation is generally deferred until money is distributed. The IRS confirms that earnings in commercial variable annuities generally are not taxed until they are distributed.

But tax-deferred does not mean tax-free.

Withdrawals generally come from earnings first

Suppose you put $100,000 into a nonqualified deferred annuity. Over time it grows to $140,000. You now have $100,000 of investment in the contract, or basis, and $40,000 of gain.

Before the annuity starting date, a nonqualified withdrawal is generally allocated to taxable earnings first under IRC §72.

If you withdraw $20,000, that $20,000 would generally be taxable ordinary income because the contract still contains $40,000 of gain. If instead you withdrew $50,000, the first $40,000 would generally be taxable earnings and the remaining $10,000 would represent recovery of basis. The IRS describes this earnings-first treatment for nonqualified annuity withdrawals.

Annuity gains are generally ordinary income

Taxable annuity earnings generally do not receive long-term capital-gains rates merely because the contract may have been held for many years. They are generally taxed as ordinary income when distributed. That difference can matter when comparing an annuity with assets held in a taxable brokerage account.

What happens when you annuitize?

Different rules apply when you formally convert a nonqualified contract into qualifying annuity payments. Generally, each payment may consist of a tax-free recovery of part of your investment in the contract, and taxable income.

The IRS calls this calculation the General Rule for many nonqualified commercial annuities. Broadly, the exclusion ratio relates your investment in the contract to the expected return under the annuity. Once the investment in the contract has been fully recovered tax-free, later payments are generally fully taxable.

What about withdrawals before age 59½?

IRC §72(q) generally imposes an additional 10% federal tax on the taxable portion of premature distributions from nonqualified annuity contracts before age 59½ unless an exception applies. The additional tax generally applies only to the taxable portion, not to the return of your own after-tax basis.

What if the annuity is inside an IRA?

Then the tax analysis changes. If a traditional IRA funded entirely with deductible or pre-tax money owns an annuity, distributions generally follow the applicable IRA tax rules.

And importantly: putting an annuity inside an IRA generally does not create an additional layer of tax deferral. The IRA already provides tax deferral. An annuity inside an IRA should therefore be justified by other features, such as contractual income guarantees, not by claiming it creates extra tax deferral.

8. If You Die Early, Does the Insurance Company Keep Your Money?

Sometimes it can retain the remaining economic value. Sometimes your beneficiaries receive the contract value. Sometimes payments continue to a spouse. Sometimes beneficiaries receive a refund. The answer depends almost entirely on the payout option and contract design.

Deferred annuity before income begins

Many deferred annuities provide a death benefit if the owner dies during the accumulation period. The beneficiary may receive the contract value or another contractually defined amount. Investor.gov notes that annuities can provide death benefits and that, before income payments begin, a named beneficiary may receive the annuity's current value or potentially more depending on the contract.

Taxable gain generally does not magically disappear at death. For a nonqualified deferred annuity, the IRS states that a death benefit received above the decedent's investment in the contract is generally included in the beneficiary's gross income. This is very different from the general income-tax treatment commonly associated with life-insurance death benefits.

Life-only immediate annuity

This is where the "insurance company keeps your money" statement comes from.

Imagine you give an insurance company $100,000 in return for $700 per month for as long as you live. If you die after receiving only 12 payments, a pure life-only contract may stop. Your beneficiaries might receive nothing further. FINRA specifically warns that a standard lifetime immediate annuity may stop at death unless the contract includes additional survivor or death-benefit provisions.

But describing this simply as the insurer "stealing" or "keeping your money" misses how the product works. You exchanged the $100,000 for a lifetime-income guarantee. Someone who dies early may receive less than the original premium. Someone who lives to 105 may receive far more than the premium. That pooling of longevity risk is part of the insurance mechanism.

Want protection for heirs?

Other payout options can be selected.

Life with period certain. Example: life with 10 years certain. Payments continue for life. But if you die during the first 10 years, the remaining guaranteed payments can generally continue to the beneficiary for the rest of that guaranteed period.

Cash refund. If you die before receiving payments equal to the amount defined by the refund provision, the beneficiary may receive the remaining amount as a lump sum.

Installment refund. The remaining refund value may continue through installments instead.

Joint and survivor. Payments continue while either covered individual remains alive, subject to the selected survivor percentage.

There is a trade-off. The more generous the survivor protection, the lower the initial income generally becomes. That is not necessarily a defect. You are purchasing more guarantees.

9. Is Your Money Locked Up in an Annuity?

Sometimes yes. Sometimes partially. Sometimes very significantly. "Locked up" can mean several different things.

Deferred annuities

Many deferred annuities have a surrender period. For example, a contract might apply surrender charges according to a schedule such as:

The actual schedule varies by product. Many contracts also permit a certain amount of money to be withdrawn annually without a surrender charge. Investor.gov notes that annuity surrender periods can last several years and that many contracts permit some annual withdrawal without a surrender charge.

That does not mean the withdrawal is necessarily free of income tax, the federal 10% additional tax before age 59½ when applicable, market value adjustments, reductions to guaranteed benefits, or other contractual consequences. These are separate issues.

Surrender charge and tax penalty are not the same thing

This is worth repeating. A surrender charge comes from the insurance contract. The 10% additional federal tax comes from federal tax law when applicable. Someone could potentially owe neither, one, or both.

Immediate income annuities

These can be substantially less liquid. Once a traditional immediate annuity is annuitized, you have generally exchanged the lump sum for the contractual payment stream. You ordinarily cannot simply decide two years later, "I would like my original $100,000 back." That is why immediate annuities should generally be funded with capital that is not needed for near-term liquidity.

Free-look period

Annuity purchasers generally receive a state-law free-look period after the contract is delivered. FINRA notes that this period is commonly around 10 to 30 days, depending on state law, during which the purchaser may review and potentially cancel the contract according to applicable requirements.

The larger planning lesson is: do not put your emergency fund into an illiquid annuity simply because the credited rate or income guarantee looks attractive. Liquidity has value.

10. Fixed, Indexed, Variable, MYGA, RILA, What Is the Difference?

This is where the entire annuity discussion becomes much easier. Think of annuities across two dimensions.

First question: when does the income start? An immediate annuity typically begins income within one year. A deferred annuity accumulates first and income may begin later.

Second question: how does the value or return work? That creates the major categories.

Fixed annuity

A traditional fixed deferred annuity credits interest according to rates established under the contract. It is generally designed for consumers seeking greater predictability rather than equity-market participation. The insurer bears the investment risk necessary to support the guarantee.

MYGA

MYGA stands for Multi-Year Guaranteed Annuity. A MYGA is essentially a type of fixed deferred annuity in which the insurer guarantees a stated interest rate for a predetermined period, such as three years, five years, seven years, or another contractual term.

Conceptually, consumers often compare MYGAs with CDs because both may offer known rates over defined periods. But they are not the same. A MYGA is issued by an insurance company, is not FDIC insured, has different tax treatment, may have different surrender rules, and relies on insurer guarantees and applicable state guaranty protections.

A 2026 NAIC research publication also describes MYGAs as fixed-deferred annuities offering guaranteed returns over defined periods.

Fixed indexed annuity

An FIA credits interest based partly on an external index while typically offering contractual protection against direct negative index performance.

Suppose the S&P 500 rises 20%. Your FIA may credit 7% because of a cap, 10% because of a participation formula, some other amount, or potentially zero depending on the specific strategy and measurement period. If the index falls 20%, a traditional fixed indexed strategy may credit 0% rather than -20%, subject to the actual contract.

That downside protection is the attraction. The limited upside is part of the trade-off.

Variable annuity

A variable annuity is much closer to an investment account wrapped inside an insurance contract. You may choose investment subaccounts containing stocks, bonds, balanced strategies, or other securities. Your value fluctuates.

Variable annuities are securities and are regulated both through state insurance regulation and federal securities regulation. They may also contain insurance guarantees such as death benefits, guaranteed lifetime withdrawal benefits, guaranteed minimum accumulation benefits, or other riders. Those benefits can make the contracts useful, but also more complicated and expensive.

RILA

RILA stands for Registered Index-Linked Annuity. A RILA sits somewhere between a traditional fixed indexed annuity and a variable annuity in terms of risk. Its performance is linked to an external index, but unlike a traditional FIA, the owner accepts some downside risk.

Common structures include a buffer, where the insurer absorbs a defined first portion of the loss, and a floor, where the owner absorbs losses up to a defined maximum, with the insurer providing protection beyond that level according to the contract.

The trade-off is that accepting some downside can allow the contract to offer greater upside potential than might otherwise be available in a traditional fixed indexed annuity. RILAs are securities and are subject to SEC and FINRA regulation in addition to state insurance oversight.

The Simplest Way to Compare Annuities

Instead of starting with the product name, start with five questions.

1. What problem am I trying to solve?

Is it longevity, predictable income, market risk, tax deferral, principal preservation, accumulation, or legacy planning?

2. What exactly is guaranteed?

Is the guarantee attached to account value, interest rate, principal, lifetime income, withdrawal amount, death benefit, or benefit base? These are not interchangeable.

3. What is not guaranteed?

Pay particular attention to caps, participation rates, renewal rates, investment performance, inflation, non-guaranteed riders, index-crediting terms, and future purchasing power.

4. What do I give up?

Understand the cost of the guarantee in terms of liquidity, fees, upside potential, flexibility, surrender charges, complexity, and access to principal.

5. What happens in the bad scenarios?

Do not evaluate an annuity only using the attractive scenario. Ask:

• What if the market crashes?
• What if rates rise after I purchase it?
• What if I need half the money next year?
• What if I die in two years?
• What if I live to 102?
• What if the insurer fails?
• What if inflation stays high?
• What if I surrender the contract early?

A strong annuity analysis should answer all of them.

The Bottom Line

An annuity is not automatically a good investment. It is not automatically a bad investment either.

It is an insurance contract that lets you exchange certain things you have, capital, liquidity, market upside, or flexibility, for things an insurer can contractually provide, such as predictable interest, downside protection, tax deferral, beneficiary guarantees, or lifetime income.

That exchange can be extremely valuable when the guarantee addresses a real financial risk. It can also be unnecessary and expensive when it does not.

The most useful question therefore isn't "Should I buy an annuity?"

It is: What problem am I asking this annuity to solve, exactly what does the contract guarantee, and is that guarantee worth the trade-offs?

If you can answer those three questions clearly, the annuity decision becomes much easier.

Important educational note

This article is for general educational purposes and does not provide individualized investment, insurance, tax, accounting, or legal advice. Annuity guarantees, surrender provisions, riders, index-crediting methods, income rates, fees, state availability, tax treatment, and guaranty-association protections vary by contract and jurisdiction. Insurance guarantees depend on the financial strength and claims-paying ability of the issuing insurer. Current product terms should be reviewed before making a purchase.