Annuity Types and Costs: Fixed, Variable, Indexed, and Immediate Annuities Explained

Fixed Annuities

A fixed annuity guarantees a specific interest rate for a set period, typically 1 to 10 years. The insurance company bears the investment risk — they invest your premium in bonds and pay you a stated rate. Current fixed annuity rates range from 4% to 6%, slightly higher than CDs or Treasuries of similar duration. The trade-off is reduced liquidity: surrender charges start at 7% to 10% and decline over 5 to 10 years. Fixed annuities are best for conservative investors who want a guaranteed return and are comfortable locking up money. The main drawback is inflation risk: a 5% fixed return may not keep pace with inflation over the long term. Some fixed annuities offer a cost-of-living adjustment rider for an additional fee. For most retirees, a CD ladder or short-term bond fund provides similar returns with greater flexibility and lower costs. Compare fixed annuities with CD ladders →

Variable Annuities

Variable annuities allow you to invest in sub-accounts — investment portfolios similar to mutual funds — giving you exposure to stocks, bonds, or other assets. Your returns depend entirely on the performance of the underlying investments. The potential for higher returns comes with significantly higher fees: mortality and expense risk charges (1% to 1.5%), administrative fees (0.15% to 0.30%), and sub-account fund fees (0.5% to 1.5%). Total annual costs typically range from 2% to 3%. A $100K variable annuity earning 7% before fees nets only 4% to 5% after fees. Over 20 years, the fee drag compounds to a difference of $100K+ compared to a low-cost ETF portfolio. Variable annuities also have death benefits and optional living benefit riders (guaranteed minimum income, withdrawal, or accumulation benefits) that add even more cost. Most variable annuities are sold by commission-based agents who earn 5% to 7% on the sale, creating a strong incentive to recommend them even when they are not the best option. Compare annuities with tax-advantaged retirement accounts →

Fixed Indexed Annuities

Fixed indexed annuities (FIAs) offer returns linked to a stock market index (typically the S&P 500) with a guaranteed 0% floor — you never lose principal due to market declines. The catch is the cap rate (typically 4% to 8%), participation rate (less than 100%), or spread/margin (deducted from index returns). These features limit your upside to ensure the insurance company profits from the difference. If the S&P 500 returns 20%, a FIA with a 7% cap credits only 7%. The index crediting method also matters: annual point-to-point, monthly sum, monthly average, and daily averaging all produce different results. Over the long term, FIAs typically credit 4% to 6% annual returns — significantly less than a simple 60/40 portfolio averaging 7% to 9%. FIAs are sold as the "best of both worlds" (upside with no downside), but the caps, participation rates, and complex crediting formulas mean you are trading significant upside potential for downside protection you may not need if you have a long time horizon. Build a diversified portfolio instead of relying on annuities →

Immediate Annuities (SPIAs)

A single premium immediate annuity (SPIA) converts a lump sum into a guaranteed lifetime income stream starting immediately. You give the insurance company $100K, and they pay you $X per month for life. The monthly payment depends on your age, gender, interest rates, and the payout option selected (life only, period certain, joint life). A 65-year-old male can expect approximately $6,500 to $7,500 per year per $100K of premium. The main advantage is longevity protection: no matter how long you live, you receive payments. The main risk is mortality risk: if you die early, the insurance company keeps the remaining principal (unless you buy a period-certain or cash-refund option, which reduces the payment). SPIAs are the simplest and most transparent annuity. They are appropriate for retirees who need to guarantee baseline income for life and are willing to trade liquidity and potential growth for that guarantee. The optimal strategy is to "longevity ladder" SPIAs — buy a small SPIA at 70, another at 75, and another at 80 — rather than committing all your savings at once.

Fee Comparison Across Annuity Types

The costs vary dramatically. Fixed annuities: 0% to 1% annual fees (built into the spread between what the insurer earns and what they credit you). Fixed indexed annuities: 1% to 2% annual fees (embedded in caps, participation rates, and spreads). Variable annuities: 2% to 3.5% annual fees (mortality and expense + administrative + sub-account fees). Immediate annuities: the cost is the insurance company's mortality and expense assumption built into the payout calculation. Surrender charges apply to fixed, indexed, and variable annuities — typically 7% to 10% declining over 5 to 10 years. By comparison, a simple portfolio of index funds and bonds costs 0.05% to 0.15% annually with no surrender charges. The annuity fee premium must be justified by the value of the guarantees — and for most investors, it is not.

What type of annuity is best for retirement income?

The best annuity for retirement income depends on your goals. For guaranteed lifetime income starting now, a SPIA is the simplest and most cost-effective. To accumulate savings with downside protection, a fixed annuity or multi-year guarantee annuity (MYGA) offers predictable returns. For upside potential with no downside risk, a fixed indexed annuity caps your returns. For market exposure with guarantees, a variable annuity with a living benefit rider might work but costs the most. Most retirees do best with a combination approach: a small SPIA to cover baseline expenses, plus a diversified investment portfolio for growth and flexibility.

How are annuities taxed?

Annuities grow tax-deferred — you pay no taxes on gains until you withdraw money. Withdrawals are taxed as ordinary income (up to 37%), not as capital gains (up to 20%). This is a significant disadvantage compared to taxable brokerage accounts, where long-term capital gains rates apply. Furthermore, annuities do not receive a step-up in basis at death — your heirs pay ordinary income tax on the gains. If you fund an annuity with pre-tax money (like from a 401(k) rollover), the entire distribution is taxed as ordinary income. Annuities held inside retirement accounts are redundant — the account already provides tax deferral.

Can I withdraw money from an annuity without penalty?

Most annuities allow penalty-free withdrawals of 10% of the account value per year. Withdrawals above that amount trigger surrender charges (typically 7% to 10% in early years, declining to 0% over 5 to 10 years). Additionally, withdrawals before age 59.5 are subject to a 10% IRS early withdrawal penalty on earnings. Some annuities have a "cumulative free withdrawal" provision that lets you accumulate unused free withdrawal amounts. Given these restrictions, only commit money to an annuity that you are confident you will not need for at least the surrender period.

What happens to an annuity when the owner dies?

What happens at death depends on the payout option. For SPIAs, a life-only option stops payments at death with no value to heirs. Period-certain options guarantee payments for a minimum term (e.g., 10 years) — remaining payments go to beneficiaries. Joint-life options continue payments to a surviving spouse for their lifetime. For deferred annuities (fixed, indexed, variable), most contracts offer a death benefit that returns at least the total premiums paid minus any withdrawals. However, heirs owe ordinary income tax on any gains. Annuities do not receive a step-up in basis at death, unlike stocks, ETFs, and real estate held in taxable accounts.

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