Annuities in retirement

In short

A friend of mine once said he wanted a paycheck in retirement, not just a pile. That is what an annuity tries to give you. You hand an insurance company a sum of money, and it promises you regular payments in return, sometimes for the rest of your life. Before you buy anything, learn what each kind promises and what it costs. Ask for the price in writing. Read the fees and the surrender terms. Check how much of your income already comes from Social Security, and then decide how much of a steady paycheck you truly need, not how much the salesperson hopes to sell. You are the one who has to live on it.

The whole of it

What it is

I once watched a retired teacher count her bills at the kitchen table, and what worried her was not the total but whether the money would last as long as she did. An annuity is a contract with an insurance company. You pay them, and they promise to pay you back over time under rules written in the contract. Those rules are everything. Read the contract.

There are a few common kinds. If you are weighing them, start with the plainest. An immediate annuity starts paying soon after you buy it. A deferred annuity waits, and you buy it now for income later. A fixed annuity pays a set rate. A variable annuity ties your account to investment funds, so its value moves up and down. An indexed annuity is a contract whose gains are figured from the rise of a market index, such as the S&P 500, but the insurer sets limits on how much of that rise you can earn, and you do not own the index itself. Each kind has a different bargain built in.

You have probably heard the word guarantee tossed around. Keep in mind that a guarantee is only as strong as the company behind it. Your state also has a guaranty association, which may step in if an insurer fails. Coverage limits differ by state, so check with your own state's insurance department.

How it works

If you are holding a sum in savings and wondering how to turn it into income, this part is for you. With a simple income annuity, you pay a premium, which is the lump sum you hand over. The company then pays you each month. Your age, your sex, the size of the premium, and the going interest rates all shape the payment. Older buyers tend to get higher payments, because the company expects to pay for fewer years.

You can pick how long it pays. A life only annuity pays until you die and then stops. A joint and survivor annuity keeps paying a spouse after you are gone, though the check is smaller to start. A period certain annuity pays for a set number of years, or to your heirs if you die early. Each extra promise lowers the monthly check. That is the price of the safety.

Deferred annuities add another step. Your money grows for a time, and then you turn it into income. Growth inside the contract is not taxed each year. You pay income tax when you take money out. Money from a deferred annuity bought with after tax dollars is taxed in part, and the part that is your own money comes back tax free. The Internal Revenue Service explains this in Publication 575, Pension and Annuity Income, which is worth a look.

Some annuities are bought inside an IRA or a workplace plan. Those follow the rules of the account, including required withdrawals. The age when those start is set by law, currently 73 for 2024 (source, checked 9/27/2026). Ask your plan or your tax preparer how an annuity fits with that.

The numbers, and where to find yours

Nobody hands you a number here without a reason, so let me tell you where to look. Start with your quote. Ask any company for a written illustration showing the monthly payment, the premium, and every fee. Get at least three, since prices differ from one firm to the next.

Look for the surrender period. That is the stretch of years when pulling money out early costs you a penalty. Look for annual fees, rider fees, and fund costs on variable contracts. A rider is an add on feature, such as a promised minimum income, and it carries its own charge. Ask for each one by name.

Check your Social Security number, too. Your statement at ssa.gov shows what you can expect at different claiming ages. Social Security already pays for life and rises with inflation, so it does part of what an annuity does. The gap between that check and your bills is what an annuity might fill.

Some limits are set by law and change by year. The tax penalty for early withdrawal from a deferred annuity applies before age the current figure, which the official source publishes each year, and the rate is the current figure, which the official source publishes each year. The amount you can put into a qualifying longevity annuity inside a retirement account is capped at the current figure, which the official source publishes each year. Look those up on IRS.gov before you act.

Also learn your company's financial strength. Rating agencies such as AM Best publish grades for insurers. A strong grade is no promise, but it beats no information.

A worked example

Consider a woman named Ruth Ellison. She is 66 and retired, and she has 400,000 dollars saved. Her Social Security check is 1,900 dollars a month, and her bills come to 3,100 dollars a month. She has a gap of 1,200 dollars each month. Here is the math: 3,100 minus 1,900 equals 1,200.

Ruth wonders whether an annuity could cover that gap, so she asks for quotes. Suppose one company offers her a life only income annuity paying 6 percent of the premium each year. Say she puts in 150,000 dollars. The yearly payment is 150,000 times 0.06, which equals 9,000 dollars. Divide by 12 months, and she gets 750 dollars a month.

That covers part of the gap. Not all. She still needs 450 dollars a month from elsewhere, since 1,200 minus 750 equals 450. She has 250,000 dollars left, because 400,000 minus 150,000 equals 250,000. That money can cover the rest and cover surprises.

Now Ruth notices something. A joint and survivor version would pay less each month. She is widowed, so she skips it. But her sister Carol, who is married, would have to weigh that cost. The 6 percent figure is Ruth's own made up number for this story, not a rate you should count on. Real quotes will differ.

She also asks one more question. What happens if she dies in year two? With life only, the payments stop, and the company keeps the rest. She decides she can accept that trade, because her goal is to never run short. Someone else might choose a period certain option and take a smaller check. Neither choice is wrong. What matters is that Ruth knew the trade before she signed.

Where it goes wrong

I have seen good people sign papers they did not fully read. The most common trouble is buying more than you need. If your Social Security and pension already cover your bills, an annuity may add cost and little else.

Another snag is locking up too much money. Once you buy an income annuity, you generally cannot get the lump sum back. Keep enough outside the contract for emergencies, for medical bills, and for a roof that suddenly leaks. Ask yourself what a surprise expense would do to you.

Fees can eat quietly into the result, especially on variable and indexed contracts with riders. Ask for the total yearly cost as a percent. Compare it to a plain income annuity, which is often simpler to understand.

Inflation matters as well. A fixed check buys less each year. Some contracts offer an inflation adjustment, but it starts with a lower payment. That is a cost you should see in numbers before deciding.

Watch for pressure, too. If someone says the offer ends today, that is a reason to slow down. A sound contract will still be there next week. You are allowed to take it home, read it, and ask a trusted person to look it over. Many states give you a free look period after buying, so ask about yours.

Questions to answer before you leave this page

How much of my monthly income is already guaranteed, and how big is the gap that is left? Have I asked for three written quotes, and do I understand every fee in them? How long is the surrender period, and could I live without that money until it ends? What happens to the payments if I die early, and who do I want protected? How strong is the company, and what does my state's guaranty association cover? Have I kept enough outside the contract for emergencies? What does inflation do to this check in twenty years? And if I sat on the porch with a friend I trust and told them my plan, would I feel easy about it?