Retirement annuities: What they are, how they work

People most commonly use annuities to create an income for themselves during their retirement years. You can set up a retirement annuity to last for a fixed period of time or for the rest of your life.

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Tory CrowleyAssociate Editor & Licensed Life Insurance AgentTory Crowley is an associate life insurance and annuities editor and a licensed insurance agent at Policygenius. Previously, she worked directly with clients at Policygenius, advising nearly 3,000 of them on life insurance options. She has also worked at the Daily News and various nonprofit organizations.

Edited by

Antonio Ruiz-CamachoAntonio Ruiz-CamachoAssociate Content DirectorAntonio helps lead our life insurance and disability insurance editorial team at Policygenius. Previously, he was a senior director of content at Bankrate and, as well as a principal writer covering personal finance at CNET.

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A retirement annuity is a contract between you and an insurance company that guarantees a stream of income for your retirement years, often for life, in return for a lump-sum payment or a series of payments over time. 

This type of annuity is known for providing a steady, reliable income stream, similar to a pension. You’ll know what to expect in terms of how your annuity will grow, and how much it’ll pay you when you’ll start to collect an income from it.

A retirement annuity can help you complement your retirement portfolio and reduce the risk that you outlive your savings, even if you live longer than you expect to. 

Key takeaways

  • A retirement annuity can be used to complement a robust financial plan after your working years. 

  • Most people should consider setting up a retirement annuity in their 50s or 60s. 

  • There are different types of retirement annuities that you can set up and customize to best meet your financial needs.

What is a retirement annuity?

A retirement annuity is an agreement between you and an insurer that guarantees a stream of income for a specific period of time, a specific amount of money, or for the rest of your life. 

Because it’s similar to a pension, many people use retirement annuities to fund their retirement years. Retirement annuities often supplement Social Security income and other sources of retirement funds.

What are the different types of retirement annuities? 

Retirement annuities are used to provide an income during your retirement years. However, there are several types of contracts you can set up as your retirement annuity, including the following. 

Fixed annuities

Fixed annuities are straightforward annuity products where your principal will grow at a fixed interest rate determined by the insurance company. You’ll know exactly how much you’ll pay, how fast your money will grow, and what your payments will be. 

While your rate of growth is guaranteed, you’ll give up the chance to have more aggressive growth through other means of investment. But if you’re looking to take a conservative approach to investing in retirement and are risk-averse, fixed annuities can offer you stable, dependable growth.

Indexed annuities

An indexed annuity offers slightly more risk and reward potential compared to a fixed annuity. Instead of having a fixed rate of growth, your contract will be tied to the performance of a market index — such as the S&P 500. 

Therefore, when the market does well, your payments will increase and when the market goes poorly, your payments will decrease — but since you’re not investing directly in the market, you won’t lose any money if there’s an economic downturn. 

Variable annuities 

A variable annuity is similar to an indexed annuity except you’ll get to decide where your principal is invested. This can be a good option for you if you’re familiar with stocks, bonds, and mutual funds and willing to take more risk with the growth rate of your annuity.

Variable annuities offer more risk than either fixed or indexed annuities. With variable annuities, your principal may lose value if the market underperforms. However, variable annuities also offer more growth potential than other annuities. 

Immediate annuities

Immediate annuities aren’t characterized by how they grow, but how they pay out. With an immediate annuity, your money will be disbursed back to you within 12 months of purchasing your contract. 

Immediate annuities are best for people who have a large sum of money and want to use those funds to set up an income stream as soon as possible, such as new retirees looking to manage their retirement savings.

Deferred annuities

Unlike immediate annuities, with a deferred annuity, there’ll be a delay of at least one year — but usually many years — between the time you pay all of your contract’s premiums and the time you start receiving financial benefits from your contract.

Deferred annuities are best for people who have the financial means to fund a contract, but won’t need access to the funds in their annuity for many years. For a retirement deferred annuity, “the sweet spot for someone, in my opinion, is an investor in their early 50’s. This gives ample time to grow the asset and income base with an eye toward their retirement,” says Jay R. Spector, certified financial planner at Everest Financial

Learn more about fixed annuities vs. variable annuities

How do retirement annuities work? 

The money you contribute to a retirement annuity grows at a rate determined by the terms of your contract. The accumulated value on your contract is then used to provide you with a stream of income with regular payments. 


Premiums are the payments you make to fund your annuity. It’s more common to fund a retirement annuity with one payment — such as your retirement savings 

If you use one payment to purchase an annuity, it’s called a single premium retirement annuity (SPIA). You’ll also have the option to purchase an annuity with several payments made over time.

Learn more about single premium vs. flexible premium annuities

Accumulation period

The accumulation period is the time between when you fully pay for your annuity and when you start being paid by it. If you choose to buy an immediate annuity, your income payments will begin right away, so your contract won’t have an accumulation period. Immediate annuities are usually funded with a single lump-sum premium payment.

But if you buy a deferred annuity, your contract does have an accumulation period and you’ll likely be able to contribute more money through multiple premium payments over time. During this time, your money will grow at a rate set by your contract.

Learn more about immediate vs. deferred annuities

Annuitization or payout phase

Once the accumulation period is over, you’ll start receiving income payments. This is called annuitization. You can set up a retirement annuity to pay you for a set period of time, a specific amount, or for the rest of your life. 

Some of the most common payout methods include: 

  • Straight life annuities last for the rest of your life, no matter how long or short that is. Also known as life only, this type of payout protects you against outliving your money, but isn’t a good option if you have dependents who you may want to leave your money to.

  • Period certain annuities dictate that you’ll be paid from your annuity for a certain number of years. If you die before that period ends, the remaining funds will be left to your named beneficiaries

  • Life with period certain annuities allow you to receive payments for the rest of your life, but if you die within a certain period, you’ll still be able to leave money to your loved ones. However, because of this guarantee, the payments you receive will be less than what you’d get from a straight life annuity.

Learn more about life only vs. period certain annuities

Surrender period

The surrender period is a time frame when you’ll be penalized for withdrawing money beyond the limits set on your contract. Many annuities will charge you a surrender fee if you withdraw more than 10% of the accumulated value of your contract per year during the surrender period. [1] Most surrender periods last for seven years, but they can be longer or shorter depending on the terms of your contract. 

Surrender fees usually decrease over time — this means you’d pay a higher penalty for withdrawals in the first year of your contract than you would in the third or fifth year. “The surrender period is usually tied to the commission schedule that the producer [who issues the annuity] receives,” says Laura K. Cook, certified financial planner at Flourish Financial Life Planning, LLC. “The longer the surrender, typically the larger the commission.”

Can annuities be used as a collateral for a loan?

Fees & penalties

If you need to withdraw funds from your annuity outside of the terms dictated in your contract, you could face extra fees and penalties, especially if you do this during the surrender period. 

As much as you can, it’s usually in your best interest to fulfill the terms of your annuity contract, as administrative fees, surrender charges, and other fees can be expensive. 

Guarantees & riders

Fixed annuities are the only types of contracts that offer you a guaranteed growth rate, but usually, their return rate is relatively low. Other contracts that offer greater potential of return, like indexed annuities, don’t offer guaranteed growth — and others, like variable annuities, could even lose money during a market downturn.

To protect yourself against loss, you can add certain features to your annuity, like adding a floor feature, which prevents your rate of growth from dropping below a certain point. 

You can also add riders to your annuity. Riders are add-ons to your contract that can offer you additional benefits and more robust coverage. 

You can usually add a rider to your annuity contract for an extra fee. But in order to offset the cost of guarantees and riders, insurance companies usually charge additional fees, which, combined with administration fees, can significantly reduce the amount of the income payments you receive.

Some of the more common riders people add to retirement annuities are: 

  • Cost of living adjustment (COLA) riders protect against inflation and guarantee that your payments will increase to keep up with inflation when necessary. 

  • Return of premium riders guarantee that if you die before your annuity pays back the money you used for the principal, any remaining balance will be paid to your beneficiaries.

  • Guaranteed minimum income benefit riders ensure that you receive a minimum amount from the annuity during your lifetime.

Generally, adding a rider or other additional features will lead to lower income payments from your contract, but the benefit may be worth it. A financial advisor can help you decide if adding a rider to your annuity contract is worth the cost.

Tax implications

You can purchase a retirement annuity with either pre-tax or after-tax funds. Either way, your money will only be taxed once. 

If you buy your annuity with pre-tax income, it’s considered a qualified annuity. You’ll have to pay taxes on each payment you receive from your contract — both on your principal and any growth. Qualified annuities are usually held in employer-sponsored accounts, like a 401(k) or 503(b) plan, but they can also be held in an individual retirement account (IRA).

Also, because they’re tax-advantaged contracts, the IRS has imposed annual contribution limits to qualified annuities — $23,000 per year if you’re under age 50, or $30,500 if you’re 50 years old or older. [2] For an IRA, the limit is $7,500 per year if you’re over 50 years old and $6,500 if you’re younger. [3]

However, if you purchased the annuity with taxed dollars, it’s considered a non-qualified annuity. You won’t pay taxes on the principal you receive back, but you’ll pay income tax on any growth accumulation. [4] Non-qualified annuities can be purchased with any after-tax funds, including savings, the sale of a large asset like a home, or money from another windfall.

Learn more about other types of annuities

What are the pros & cons of retirement annuities?

Retirement annuities offer different features that may or may not work to your advantage. If you know the pros and cons of retirement annuities, you can decide if setting one up can be helpful to you. 


  • Risk protection. A retirement annuity can protect you against the risk of outliving your savings. 

  • Reliable income. You can set up a reliable income not subject to market fluctuations — especially if you choose a fixed annuity. 

  • Complement to a retirement plan. If you already have Social Security income or a retirement account like a 401(k), a retirement annuity will help create a more robust financial plan for your retirement years by adding a steady source of income. 


  • Lack of liquidity. It can be costly to deviate from your original contract within a retirement annuity. If an emergency happens and you need to withdraw money early, it’ll be time-consuming and expensive. 

  • No inflation protection. The income that comes with a retirement annuity won’t necessarily keep up with inflation, and your money could lose value over time. Some retirement annuities may allow you to add a cost of living adjustment (COLA) rider, which protects your contract against inflation, but add-ons like this usually come with fees that reduce the amount of your income payments.

  • Surrender charges. If you surrender part of your annuity early, you’ll have to pay fees, and you could end up losing money overall.

Learn more about how annuities work

What should you consider before buying a retirement annuity?

While an annuity can be a good financial tool, be sure it’s in your best interest before you purchase one. To determine if an annuity is right for you, consider your age, investment goals, and risk tolerance. 

Your age

The majority of people use retirement annuities to create an income stream during retirement, so it’s common to consider a contract when you’re in your 50s or 60s. 

“Most people begin considering retirement annuities as they approach their mid-50s to early 60s, aligning with the typical retirement planning horizon,” says Alyson Basso, certified financial planner and managing principal at Hayden Wealth Management. “This is the age range where individuals start to seriously evaluate their long-term financial security and look for ways to ensure a stable income once they stop working.” 

However, there’s no age limit for setting up a retirement annuity. If you come into a large sum of money through an inheritance or some other windfall, you can set up a retirement annuity to help manage the funds. 

Your investment goals

Retirement annuities can often be customized to meet your investment goals. You can set up your annuity to grow at a low, guaranteed rate, or if you’re more risk-tolerant, you can set up your annuity to grow with the market, potentially gaining or losing more over time. 

If you have ambitious investment goals, setting up a retirement annuity may not necessarily be your best option, and you may be better off investing in the stock market directly. 

Your risk tolerance 

Retirement annuities are generally best for people who are risk-averse and want to establish a reliable source of income during retirement. While there’s variance between fixed, indexed, and variable annuities and how risky they are, annuities in general are considered less risky than other investment options. 

Annuities are optimized for reliability, not ambitious growth or high risk. 

Are annuities a good investment?

Who should consider a retirement annuity? 

You should consider a retirement annuity if you have money to fund your retirement and want to use those funds to set up a regular income. Setting up a retirement annuity creates a steady source of income, but it does usually mean forfeiting the opportunity for more lucrative investments. 

Consider a retirement annuity if the stability of an income is a better use of your money than investing with the ultimate goal of growing your money more aggressively.

Explore other annuity options


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Policygenius uses external sources, including government data, industry studies, and reputable news organizations to supplement proprietary marketplace data and internal expertise. Learn more about how we use and vet external sources as part of oureditorial standards.

  1. IRS

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    Publication 575 (2023), Pension and Annuity Income

    ." Accessed May 28, 2024.

  2. IRS

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    Retirement topics: 401(k) and profit-sharing plan contribution limits

    ." Accessed May 28, 2024.

  3. IRS

    . "

    IRS FAQs

    ." Accessed May 28, 2024.

  4. Insurance Information Institute

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    What are the different types of annuities?

    ." Accessed May 28, 2024.


Tory Crowley is an associate life insurance and annuities editor and a licensed insurance agent at Policygenius. Previously, she worked directly with clients at Policygenius, advising nearly 3,000 of them on life insurance options. She has also worked at the Daily News and various nonprofit organizations.


Antonio helps lead our life insurance and disability insurance editorial team at Policygenius. Previously, he was a senior director of content at Bankrate and, as well as a principal writer covering personal finance at CNET.

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