Annuity

Two phases

Most annuities have two phases:

• Accumulation — the buyer pays into the contract, either as a lump sum or in installments. The balance grows on a tax-deferred basis.
• Annuitization — the contract converts the accumulated balance into a stream of payments, either for a fixed term or for life.

You can also buy an "immediate annuity," which skips the accumulation phase entirely — pay a lump sum today, start receiving payments next month.

Main types

• Fixed annuity — pays a guaranteed interest rate and (after annuitization) a guaranteed payout. The simplest, lowest-risk variant.
• Variable annuity — accumulation balance is invested in a menu of subaccounts (essentially mutual funds). Payouts vary with portfolio performance, often with a guaranteed minimum.
• Indexed annuity — return is linked to a market index (typically the S&P 500) with a participation rate and a cap. Often marketed as "market upside, no downside" — accurate in narrow technical sense, but the caps materially reduce returns.

Why people buy them

The single use case where annuities are unambiguously the right product is longevity insurance: the risk of outliving your savings. A life annuity continues paying as long as you're alive, which neither a portfolio nor Social Security alone can fully guarantee. For retirees with no pension and meaningful concern about a long life, an immediate fixed annuity converts a portion of savings into guaranteed lifetime income that can't be outlived.

Why most personal-finance writers are skeptical

Most variable and indexed annuities sold by commission-paid advisors carry layered fees (mortality and expense charges, subaccount fees, rider fees) that significantly reduce long-run returns relative to a comparable mix of an IRA plus a low-cost index fund. The complexity is its own cost — most buyers can't fully reproduce the contract terms a year after purchase. Surrender charges typically lock the funds for five to ten years.

The cleaner version of the longevity-insurance use case is a single-premium immediate annuity (SPIA) from a low-load provider, bought near retirement. Strip away the riders and additional features, and what remains is a simple, predictable income stream.

Compared to a 401(k) or IRA

Unlike a 401(k) or Traditional IRA, an annuity is not a tax-advantaged wrapper — it's a contract with an insurance company. The tax deferral applies, but contributions to a non-qualified annuity aren't deductible. Most retirement planning frameworks suggest filling employer-match and IRA capacity first, considering annuities only after maxing those out.