Know Your Annuity Basics

Oct 05, 2015

MoneyLife100 Many things in life are uncertain, and retirement is no exception. With longer life spans and unpredictable economic factors, investors are looking for ways to stretch their retirement dollars. Annuities may be one way to help provide you with a steady stream of income during your retirement years. The Pennsylvania Institute of Certified Public Accountants (PICPA) offers the following information to help you decide if an annuity is the right option for you.

What Is an Annuity? 

An annuity is a contract between you and an insurance company that entitles you to a set amount of money for a period of time immediately or at some point in the future. If payments are to start immediately, you have an immediate annuity. If payments are delayed until some possible future date, you have a deferred annuity. Some annuities are funded with a single payment (called a premium), while others can be funded with many payments and over a long period of time.

Types of Annuities

Before buying an annuity, it is important to understand the different types of annuities. There are three  basic types: fixed, variable, and indexed. It’s critical that you understand the benefits and structure of each. 

Fixed Annuity 

In a fixed annuity the insurance company guarantees both the rate of return and the payout. Annuitization options include a set payment for a specific time or for a lifetime. Fixed annuities provide a stable income. This helps protect your payments from swings in the marketplace. 

Variable Annuity 

A variable annuity offers the potential to grow your payments by investing among a selection of subaccounts that resemble mutual funds. The rate of return is based upon the performance of these funds. 

Indexed Annuity 

This is a hybrid product which is also referred to as an “equity-indexed annuity” or a “fixed-indexed annuity.” It has characteristics of both fixed and variable annuities, offering a minimum interest rate guarantee plus the potential to earn more if an underlying market index performs positively.  


In addition to the type of annuity, you’ll also need to choose when you want to start receiving payments. There are two types of payouts: immediate and deferred. 


With this option you start receiving payments immediately. For investors that need funds right away, an immediate annuity may be a good option.  


With deferred annuities, you start receiving payments sometime in the future, usually at retirement. The money you invest can grow tax-deferred for several years until you need it. Deferred annuities are typically best for investors that don’t need immediate funds and have time to watch their money grow. 

Before You Buy 

There are a few things you should review before purchasing an annuity. Here are a few basic considerations when evaluating an annuity: 

Fees and Charges 

Fees can greatly affect the performance of your annuity. Before choosing an annuity, be sure to understand the fees, commissions, and penalties associated with the annuity. 

Investment Options 

With a fixed annuity, you’ll know exactly how much you will earn. However, variable annuities typically offer a number of investment options. It is important to review the types of investments available to help ensure you maximize the growth potential of your annuity. 

How much to invest?

Determining how much to invest in an annuity can be difficult. One method includes adding all your essential retirement expenses then subtracting any guaranteed retirement funds such as Social Security or a pension. The resulting gap may be a start in estimating the monthly annuity payout you may consider. 

Annuity Issuer 

Keep in mind that annuities are insurance products. Before choosing an annuity, you’ll want to make sure the insurance company (issuer) is a highly rated and financially stable company. 

Lifetime Guaranteed Benefits 

Some annuities offer guaranteed benefits to help offset the financial market risks. Below are a few guaranteed benefits to consider when purchasing an annuity. 

Guaranteed Death Benefit 

Some annuities offer a guaranteed death benefit. If you die before the annuity begins paying benefits, this guarantees your beneficiary receives a death benefit. Typically, the guaranteed death benefit offers the beneficiary either the current market value of the annuity or the amount of the initial investment minus any withdrawals. 

Guaranteed Minimum Income Benefit 

Variable annuities may offer investors the option to add the guaranteed minimum income benefit rider to their annuity. The guaranteed minimum income benefit ensures you will receive a stated ongoing payment regardless of market conditions. These riders are usually at an additional cost and many have specific limits, so carefully evaluate the guaranteed minimum income benefit option before adding it your annuity. 

Pros and Cons

Guaranteed income for retirement seems like a great option, but there are many pros and cons when it comes to annuities.  


Provides a Guaranteed Income Stream 

With all of the uncertain factors and changes you may face in your retirement, annuities can provide a guaranteed income stream when you need it the most. 

Tax deferment 

Money invested in an annuity grows tax-deferred. When you start making withdrawals, the earnings portion is taxed at your current income tax rate. However, the principal portion is not taxed, so this can be a significant amount of tax savings. 

Don’t Outlive Income 

Annuities can be designed to help ensure you don’t “outlive” your income. These products can give you ease of mind by providing a steady stream of income for a lifetime or a set period of time. 

No Contribution Limits 

There is no annual contribution limit for annuities, unlike other retirement accounts such as 401(k)s and IRAs. Since there is no contribution limit, investors can choose to put as much money away for retirement as they wish. 



Annuities can carry high fees, sales commission, and charges. Often these are hidden in the fine print, such as underwriting fees, fund management, and penalties. Although not all annuities have high fees, it is important to consider how they affect the overall performance of your funds. 

Early Withdrawal Penalties 

After you invest in an annuity, you may lose access to the initial principal and your contributions. If you make an early withdrawal on a deferred annuity, you could face serious penalties from the insurance company. In addition, if you withdraw funds before 59 ½, you may be charged a 10 percent penalty from the IRS. 

Giving Up Access to Your Savings 

In exchange for the guaranteed income stream, you are giving up access to a portion of your savings. If you need the funds before the annuity is scheduled to make payments, you may face penalties and fees. Therefore, if you need to access your savings, you’ll want to carefully consider if annuities are the best option for you and for what portion of your funds. 


Annuities can be hard to understand, especially with multiple types of annuities, benefits, and options. If you are considering investing in an annuity, it is best to speak with a professional before adding it to your retirement strategy. 

Turn to Your Local CPA

While this article provides a general overview of some of the key points related to annuities, everyone’s financial situation is unique and requires careful consideration. Your local CPA is the best source of advice for your important financial decisions. For resources, including PICPA’s CPA locator, visit

The Pennsylvania Institute of Certified Public Accountants (PICPA) is a premiere statewide association of more than 22,000 members working in public accounting, industry, government, and education. Founded in 1897, the PICPA is the second-oldest state CPA organization in the United States.

Money & Life Tips are a joint effort of the AICPA and the Pennsylvania Institute of Certified Public Accountants (PICPA), as part of the profession’s nationwide 360 Degrees of Financial Literacy program.