Annuities have a polarizing reputation in the financial world. Insurance agents love them; fee-only financial planners often don’t. The truth is more nuanced: annuities for retirement income can be genuinely useful tools in the right circumstances, and genuinely harmful in the wrong ones.

This guide cuts through the marketing and explains what annuities actually do, what they cost, and when they belong — or don’t belong — in a retirement income strategy.

What Is an Annuity?

An annuity is a contract with an insurance company. You give the insurer money (either a lump sum or over time), and in exchange the insurer promises to pay you a stream of income, either for a fixed period or for your lifetime.

The core value proposition is longevity insurance — you can’t outlive an income stream that pays for life. This is the same fundamental promise made by Social Security and traditional pensions, which is why annuities appeal to retirees who lack pension income.

Annuities are insurance products, not investments. They’re regulated by state insurance departments, not the SEC. This matters because the financial incentives — commission structures, surrender charges, and product complexity — differ from the investment world.

Types of Annuities: A Clear Map

The annuity market has expanded dramatically, and the terminology can be confusing. Here are the main categories:

Immediate Annuities (SPIAs)

A Single Premium Immediate Annuity (SPIA) is the simplest form. You pay a lump sum and payments begin within a month. There’s no accumulation phase — you’re purchasing income directly.

How payouts work: A 70-year-old man paying $200,000 for a life-only SPIA might receive approximately $1,200–$1,400/month for life in 2025, depending on the insurer and interest rate environment. A joint-life SPIA (covering a couple) would pay less — around $1,000–$1,200/month — because the insurance extends over two lives.

Payout options:

  • Life only: Payments end at death, even if you die the next month
  • Life with period certain: Payments guaranteed for a minimum period (10 or 20 years); if you die early, payments continue to heirs for the remaining period
  • Joint and survivor: Payments continue to spouse after your death, often at 100% or 50% of the original amount

SPIAs are transparent, low-cost (no ongoing fees), and deliver exactly what they promise. They’re the annuity structure most financial planners respect.

Deferred Income Annuities (DIAs) / Longevity Annuities

A Deferred Income Annuity works like a SPIA but with a waiting period before income begins. You buy it at 65, income starts at 80. Because payments are deferred, the monthly income when it begins is substantially higher.

A Qualified Longevity Annuity Contract (QLAC) is a DIA purchased inside a traditional IRA. As of 2024, you can contribute up to $200,000 of IRA funds to a QLAC. The portion in the QLAC is excluded from Required Minimum Distribution (RMD) calculations until the QLAC begins paying out (maximum deferral age: 85).

This makes QLACs useful for managing RMD exposure while maintaining longevity protection. See our guide on required minimum distributions for more on the RMD-reduction strategy.

Fixed Deferred Annuities

A fixed deferred annuity accumulates value at a guaranteed interest rate before you annuitize or withdraw. Think of it as a CD-like product inside an insurance wrapper.

Multi-Year Guaranteed Annuities (MYGAs) are fixed-rate annuities that guarantee a specific interest rate for a set period (3–10 years). A MYGA paying 5.2% for 7 years is directly comparable to a 7-year CD at 5.2% — but annuity gains are tax-deferred, while CD interest is taxable annually.

For retirees in high tax brackets who want a low-risk, tax-deferred vehicle, MYGAs can legitimately outperform CDs on an after-tax basis.

Variable Annuities

Variable annuities invest your premium in mutual fund-like subaccounts. The account value fluctuates with market performance. Most variable annuities include optional riders — guaranteed minimum income benefits (GMIBs), guaranteed minimum withdrawal benefits (GMWBs), or guaranteed minimum accumulation benefits (GMABs) — that promise income floors regardless of account performance.

Variable annuities are the most complex and often most expensive category. Annual fees can reach 3–4% when you add the base mortality and expense charge, investment management fees, and rider fees. That’s a heavy drag on returns.

Unless the specific rider benefits genuinely meet your needs at a cost you understand, variable annuities are often better avoided. The complexity is often in the insurer’s favor.

Fixed Indexed Annuities (FIAs)

Fixed indexed annuities link credited interest to a market index (usually the S&P 500) with a floor of 0% — you can’t lose principal. Gains are capped or subject to a “participation rate” (e.g., you receive 50% of the index’s gain).

FIAs occupy a middle ground between fixed and variable. They offer principal protection and the possibility of higher returns than pure fixed annuities, but actual gains tend to be modest because of caps and participation rate structures.

FIAs are aggressively sold due to high commissions (often 6–8% or more). That commission isn’t explicit — it’s embedded in the product’s structure. The more features an FIA has, the more the structure typically benefits the insurer.

The Real Cost of Annuities

Understanding annuity costs requires looking beyond the explicit fee schedule.

SPIAs and DIAs: Essentially no ongoing fee. The insurer’s profit margin is built into the payout rate — you can compare payout rates across insurers to find competitive pricing.

MYGAs: No ongoing fees. The spread between what the insurer earns on your money and what they credit to you is the profit margin. Again, compare rates.

Variable annuities: Annual fees of 1.5–4%, comprising:

  • Mortality and expense (M&E) charge: 0.5–1.5%
  • Administrative fees: 0.1–0.3%
  • Subaccount fund expenses: 0.5–1.5%
  • Rider fees: 0.5–1.5% each

At 3% annual drag, a $300,000 variable annuity costs $9,000/year. Over 20 years, with compounding, this is an enormous transfer from policyholder to insurer.

FIAs: No explicit ongoing fees, but the cap/participation structure limits your upside. Surrender charges (typically 7–10 years) lock you in.

Surrender charges: Most deferred annuities have surrender periods — if you withdraw early, you pay a percentage penalty (often 7–10% in year 1, declining to 0% over 7–10 years). This illiquidity is a real cost that’s often underweighted by buyers.

When Annuities Make Sense

Despite the criticism, annuities have legitimate use cases:

1. You lack pension income and worry about outliving assets

If you have no defined benefit pension and your Social Security income doesn’t cover essential expenses, annuitizing a portion of your savings creates a guaranteed income floor. Knowing that basic expenses are covered regardless of market performance reduces anxiety and simplifies investment decisions.

2. You want to simplify income management

Managing a portfolio in retirement — deciding withdrawal rates, rebalancing, avoiding sequence-of-returns risk — is cognitively demanding. For retirees who don’t want to manage this, or who anticipate diminishing capacity, an annuity handles income automatically.

3. Longevity risk is high

If you have a family history of long life, are currently healthy at 70, and have reason to expect living to 90 or beyond, the longevity protection of a SPIA becomes more valuable. The longer you live, the more you benefit relative to what you paid.

4. QLAC to manage RMD exposure

If you have a large traditional IRA, a QLAC can defer income and RMDs from a portion of the account, which may reduce Medicare IRMAA surcharges and keep more of your income taxed at lower rates. This is a specific, quantifiable benefit worth analyzing.

5. MYGA for tax-deferred fixed income

If you’re in a high tax bracket and want bond-like exposure without annual tax on interest, a MYGA can outperform a CD on an after-tax basis. This is a straightforward comparison — just run the numbers.

When Annuities Don’t Make Sense

1. You already have substantial guaranteed income

If Social Security and pension income already cover your essential expenses, you don’t need more guaranteed income. Adding an annuity reduces liquidity without solving a real problem.

2. You need liquidity

Annuities are illiquid during surrender periods and permanently illiquid once annuitized (for the most part). If you might need the capital — for healthcare costs, home modifications, helping family — locking it up is a serious risk.

3. You’re in poor health

A life annuity is actuarially priced assuming average mortality. If your health is significantly below average, you’re subsidizing other policyholders. A shorter break-even period (when cumulative income exceeds premium paid) means poor health is a real financial disadvantage.

4. You’re buying primarily for the upside

FIAs and variable annuities are sometimes sold as ways to “participate in market gains without downside risk.” But the caps, participation rates, and fee structures ensure that in most scenarios, you’d have done better with a simple stock/bond portfolio. Don’t buy an annuity as a growth vehicle.

5. You don’t understand the product

Annuity contracts are long, complex documents. If you can’t clearly explain what the product does, what it costs, and under what scenarios it performs well or poorly, that’s a red flag. Complexity often serves the seller, not the buyer.

How to Shop for an Annuity

If you decide an annuity fits your situation:

Compare payout rates: For SPIAs and MYGAs, use an annuity shopping service (such as Cannex or Blueprint Income) to compare quotes from multiple insurers. Even a 5–10% difference in payout rate matters significantly over decades.

Check financial strength ratings: Since you’re trusting an insurer with a long-term obligation, verify their financial strength. Look for A or better from A.M. Best, or equivalent from Moody’s or S&P. Most states have guaranty associations that cover annuity claims up to $250,000 if an insurer fails, but that’s a floor, not a guarantee of full recovery.

Work with a fee-only advisor: If you’re evaluating complex annuities, consider a fee-only financial planner who doesn’t earn commissions — they can give unbiased advice. Avoid purchasing annuities solely on the recommendation of someone who earns a commission from the sale.

Run the break-even calculation: For a life annuity, calculate how long you need to live for cumulative income to exceed your premium. For a 70-year-old buying a $200,000 SPIA paying $1,300/month, the break-even is roughly 12–13 years — meaning at 82–83 you’ve recovered your principal, and every payment after that is pure longevity benefit.

Annuities and Retirement Tax Planning

Annuities inside an IRA are funded with pre-tax dollars — all income is taxable at withdrawal. This is the same treatment as any other traditional IRA distribution.

Annuities purchased with after-tax dollars have an “exclusion ratio” — the portion of each payment that represents return of premium is excluded from income; only the gain portion is taxable. This improves after-tax income compared to a fully taxable pension or traditional IRA distribution.

Roth IRA-funded annuities are rare and complex — generally not a recommended structure. The tax-free Roth withdrawals are usually more flexible without the annuity wrapper.

The Bottom Line

Annuities for retirement income are not universally good or bad — they’re tools with specific appropriate uses. A SPIA or DIA genuinely solves the longevity risk problem and deserves consideration if you lack adequate guaranteed income. MYGAs can serve a specific tax-deferral role.

Variable annuities and most FIAs, especially when loaded with riders, are expensive products that rarely justify their complexity. Approach them with skepticism proportional to the commission the seller earns from the sale.

The right approach: identify the specific problem you’re trying to solve (longevity risk, income certainty, tax deferral), then evaluate whether an annuity is the most cost-effective solution compared to alternatives like delaying Social Security, building a bond ladder, or adjusting your withdrawal strategy.

For a complete picture of retirement income planning, see our guides on Social Security timing, required minimum distributions, and retirement tax planning.