An annuity is a financial contract between you and an insurance company in which you pay a lump sum or make regular payments in exchange for guaranteed income—either immediately or at some point in the future. Unlike savings accounts or investment portfolios that you manage yourself, an annuity transfers the investment risk and longevity risk to the insurance company, which commits to paying you for life, regardless of market conditions or how long you live. For a retiree worried about outliving their savings, an annuity can provide predictable monthly income that never stops, making it one of the few guaranteed lifetime income solutions available in retirement planning. The annuity market has been growing significantly, reflecting increasing interest in this strategy.
U.S. retail annuity sales reached $464.1 billion in 2025, marking the fourth consecutive year of record sales and a 7% increase from 2024. As approximately 4.1 million Americans turn 65 each year, demand for lifetime income solutions like annuities continues to rise. Understanding how annuities work, what types exist, their costs, and whether they fit your retirement plan is essential for anyone approaching or in retirement.
Table of Contents
- What Is an Annuity and How Does It Provide Lifetime Income?
- Types of Annuities and What Each One Offers
- How Annuities Compare to Other Retirement Income Strategies
- Understanding Costs, Fees, and the Trade-Off Between Safety and Returns
- Common Risks and Important Limitations of Annuities
- The Current Annuity Market and Recent Trends
- Is an Annuity Right for Your Retirement Plan?
- Conclusion
What Is an Annuity and How Does It Provide Lifetime Income?
An annuity works by pooling your money with other policyholders, allowing the insurance company to calculate life expectancy across the entire group and use that data to offer sustainable lifetime payments. When you purchase a deferred annuity—one that begins paying you later—you’re essentially betting on your longevity, while the insurance company spreads the risk across thousands of other customers. If you live longer than average, the insurance company honors its commitment to keep paying you. If you pass away earlier than expected, your remaining funds typically go to beneficiaries or become the property of the insurance company, depending on your contract terms. Consider a 65-year-old retiree with $250,000 to invest.
Rather than withdrawing 4% annually from a portfolio ($10,000 per year) and risking that money runs out by age 90 or 95, they could purchase an immediate annuity that pays $1,300 per month for life. That guaranteed income can serve as a foundation for essential expenses—mortgage, utilities, food—while investment portfolios handle discretionary spending. The trade-off is clear: certainty now in exchange for giving up access to the principal and accepting lower returns than stocks might theoretically provide. The insurance company’s promise is backed by its financial strength and state insurance guarantees, which typically protect annuity holders up to $250,000 per carrier if the company becomes insolvent. This is a critical distinction from stock investments, which have no such guarantee. However, this safety comes at a cost in the form of fees and the insurance company’s profit margin, which is why annuity payouts are typically lower than what you might earn investing aggressively in the stock market over the same period.
Types of Annuities and What Each One Offers
The annuity market includes several distinct types, each designed for different goals and risk tolerances. Fixed annuities, the most straightforward option, guarantee a specific interest rate for a set period. A multi-year guaranteed annuity (MYGA)—essentially a CD alternative—currently offers rates up to 6.50% for 7-year terms from A-rated insurance carriers, with 5-year options in the 5.0% to 5.8% range as of April 2026. If you purchase a 7-year MYGA for $100,000 at 6.50%, you receive that interest rate annually with no market risk, though you’re locked in for the full term and typically face surrender charges if you withdraw early. Fixed indexed annuities (FIAs) offer a middle ground between fixed annuities and variable annuities. They credit returns based on a stock market index like the S&P 500, but cap your gains—currently between 8% and 14% annually depending on the product—and protect against market losses. A cap of 10% means if the S&P 500 surges 25% in a year, your account only grows by 10%.
Conversely, if the market drops 20%, your account doesn’t decline at all. This appeals to savers seeking growth potential without bearing the full brunt of market downturns, though the caps reduce your upside compared to direct stock ownership. Variable annuities allow you to invest in mutual fund-like subaccounts, giving you direct exposure to stock and bond markets. These products appeal to investors with higher risk tolerance and longer time horizons, but they also charge higher fees—often 1-3% annually—to cover the insurance company’s risk management. Immediate annuities, by contrast, begin paying you within a year of purchase and are typically purchased with a lump sum. You cannot add contributions after purchase, and your payments are fixed (or tied to an index). The Department of Labor recently recognized that lifetime income components in variable annuities can justify additional fees, acknowledging their value in providing security but also signaling regulatory scrutiny of cost structures.
How Annuities Compare to Other Retirement Income Strategies
A portfolio-based retirement strategy using a “4% rule” or dynamic withdrawal approach offers flexibility, liquidity, and the potential for higher growth, but requires active management and exposes you to sequence-of-returns risk—the danger that a market crash early in retirement depletes your savings faster than you can recover. For example, a retiree who starts withdrawing from a stock-heavy portfolio in 2008, during the financial crisis, faces significantly different outcomes than someone who started in 2009 after the market recovered. An annuity eliminates this sequence risk because your income check arrives regardless of whether stocks are up or down. However, annuities sacrifice flexibility and liquidity. Once you purchase an immediate annuity, you cannot recover your principal or redirect that money if circumstances change.
If you purchase a $250,000 annuity and pass away one year later, that money is gone unless you purchased a “period certain” or “refund” rider, which lowers your monthly payment. A portfolio-based approach lets you leave unspent assets to heirs. Some retirees use a hybrid approach: purchase an annuity to cover essential expenses (social security plus an immediate annuity might cover rent, utilities, and groceries), and invest remaining assets for growth and discretionary spending. This balances guaranteed income security with flexibility and growth potential. Bonds and bond funds offer interest income with liquidity and the ability to recover principal, but they don’t provide guaranteed lifetime income and can decline in value if interest rates rise. A bond ladder—a series of bonds maturing at different dates—offers predictable income but requires you to reinvest maturing bonds at whatever rates are available at that time, exposing you to interest rate risk.
Understanding Costs, Fees, and the Trade-Off Between Safety and Returns
Annuity costs vary significantly by type and product. Fixed annuities typically charge lower internal fees (often bundled into the rate they offer) but provide lower returns—currently 5-6.5% for MYGAs versus historical long-term stock market returns of 10% or so. FIAs charge higher internal costs (sometimes 0.5-1.5% annually) due to the complexity of hedging, index options, and insurance guarantees. Variable annuities charge the highest fees—typically 1-3% annually for the insurance wrapper alone, plus the cost of underlying mutual funds. A 2% annual fee might not sound large, but compounded over 20 years, it significantly reduces your wealth. Surrender charges are another critical cost. If you purchase a 7-year MYGA and need to access your money after 3 years, you may face a 6% surrender charge on top of losing the remaining interest. These charges decline each year but can be substantial if you experience a major life event requiring liquidity.
Always review the surrender charge schedule before purchasing. Some annuities also charge mortality and expense (M&E) fees, administrative fees, and riders for living benefits, all of which stack up. A product that looks attractive at 6% interest might net only 4% after all fees. The trade-off is explicit: you pay these costs in exchange for guarantees. The insurance company invests conservatively, earns its own returns, takes a profit, and passes the remainder to you. This is fundamentally different from a brokerage account where you keep all investment gains or losses. Whether the trade-off is worthwhile depends on your circumstances—someone highly anxious about market volatility or running out of money may find the peace of mind worth the cost. Someone with a strong pension and substantial assets may not.
Common Risks and Important Limitations of Annuities
Inflation erodes the purchasing power of fixed annuity payments. If you purchase an immediate annuity paying $1,300 per month and inflation averages 3% annually, that same $1,300 buys significantly less in 20 years. Some annuities offer inflation-adjusted payments or cost-of-living adjustment (COLA) riders, but these reduce your initial monthly payment. A $1,300 payment without COLA might become $970 in real purchasing power after 20 years of 3% inflation, which is a substantial impact on your standard of living. Liquidity risk is another significant limitation. Unlike a savings account or investment portfolio, you cannot quickly access your money if you need it. If you purchase an annuity and face unexpected medical expenses or a family emergency requiring $50,000, you’re stuck with surrender charges or no access at all, depending on the product.
This is why financial advisors recommend using annuities only for money you’re confident you won’t need to access in the near term. Always maintain an emergency fund separate from annuity assets. Issuer risk, though regulated, is real. The insurance company must remain solvent to pay you for decades. State insurance guaranty funds protect policyholders up to $250,000 per state per carrier if a company fails, but if you have a $300,000 annuity and the issuer goes bankrupt, you lose $50,000. Research the financial ratings of insurance companies before purchasing—use agencies like A.M. Best or Moody’s to verify their strength.
The Current Annuity Market and Recent Trends
Annuity sales surged in Q4 2025, jumping 14% to $117.2 billion, marking the ninth consecutive quarter exceeding $100 billion. This growth reflects both higher interest rates—which make fixed annuities more attractive—and demographic tailwinds. LIMRA projects annuity sales to remain above $450 billion in 2026, with Retail Income Annuities (RILAs) expected to exceed $85 billion.
Higher interest rates have made fixed annuities significantly more compelling than they were in 2021-2022, when rates hovered near 2-3%. This environment represents a genuine shift in the risk-return landscape. Savers can now access 6%+ guaranteed returns from annuities, making them competitive with expected stock returns for the first time in years. As interest rates normalize after the extended period of near-zero rates, annuities have regained their appeal for conservative investors and retirees.
Is an Annuity Right for Your Retirement Plan?
An annuity makes the most sense if you have a strong desire for guaranteed income, low risk tolerance, or concern about outliving your savings. If your social security benefits and pension (if you have one) already cover your essential expenses, an annuity may not be necessary. If you have significant assets and a long time horizon, a diversified portfolio might provide better growth. But if you’re worried about market downturns in early retirement, sleep poorly when markets decline, or have outlived relatives making you concerned about longevity, an annuity can provide valuable peace of mind.
The regulatory environment continues to evolve, with increased attention to how lifetime income products are marketed and presented. Recent developments suggest the Department of Labor recognizes the value of guaranteed income but is scrutinizing costs. As the annuity market matures and competition increases, consumers may benefit from better pricing and more transparent fee structures. Working with a fee-only financial advisor—not one paid commission on annuity sales—ensures you get unbiased guidance on whether an annuity aligns with your specific situation.
Conclusion
An annuity is a powerful tool for converting savings into guaranteed lifetime income, eliminating sequence-of-returns risk and longevity risk while sacrificing liquidity, flexibility, and growth potential. Understanding the different types—fixed annuities, fixed indexed annuities, and variable annuities—and their respective costs and benefits is essential for evaluating whether they belong in your retirement plan. The current market environment, with above-5% fixed annuity rates and continued strong sales growth, has made annuities more compelling for conservative investors than they’ve been in years.
Before purchasing an annuity, assess your risk tolerance, time horizon, liquidity needs, and financial priorities. Compare multiple products from highly-rated insurance companies, fully understand surrender charges and fees, and consider consulting a fee-only financial advisor. An annuity may serve as a portion of your retirement income strategy—perhaps covering essential expenses while investments handle growth and discretionary spending. The right decision depends entirely on your circumstances, not on market trends or sales statistics.