Retirement used to mean a pension check arrived every month without fail. For most people today, that guaranteed paycheck is gone, replaced by a 401(k) balance that can shrink in a bad market or a savings account earning next to nothing.
The question most retirees quietly wrestle with is not whether they have enough money, it is whether their money will last as long as they do. Annuities offer one concrete answer to that question, and understanding how they actually work can change the shape of a retirement plan in a meaningful way.
Key Takeaways
- Annuities convert a lump sum into guaranteed monthly income that cannot be outlived.
- Fixed and fixed-indexed annuities protect principal from market losses while still generating growth.
- The right annuity type depends on timeline, risk tolerance, and income needs.
The Problem With “Just Investing” in Retirement
The standard advice for decades was simple: save aggressively, invest in a diversified portfolio, and withdraw 4% annually in retirement. The 4% rule, developed from research by financial planner William Bengen in 1994, was based on historical U.S. market data.
The problem is sequence-of-returns risk, meaning a major market drop in the first few years of retirement can permanently damage a portfolio even if markets eventually recover. A retiree who lost 30% of their portfolio in 2008 and kept withdrawing 4% was drawing from a far smaller base, which many never fully recovered from.
That is not a hypothetical. The S&P 500 dropped approximately 38.5% in 2008. Someone retiring that year with $1,000,000 in stocks would have seen their balance fall to roughly $615,000 while still needing to pull income. The math compounds against them from that point forward.
A person who retired in 2000, just before two back-to-back market downturns, faced the same trap even with a conservative withdrawal rate.
Annuities sidestep that problem entirely. Because the income amount is contractually guaranteed, there is no forced selling of assets at depressed prices, and no month where the check does not arrive because the market had a rough quarter.
What an Annuity Actually Does
At its core, an annuity is a contract between a buyer and an insurance company. The buyer hands over a sum of money, either all at once or over time and the insurer guarantees a stream of income payments in return.
Those payments can begin immediately or at a future date, and they can be structured to last for a set number of years or for the rest of the buyer’s life, whichever comes later.
That last part matters. A lifetime income rider on an annuity means payments continue even if the account balance reaches zero. The insurance company absorbs the longevity risk. That is the core trade: the buyer gives up some flexibility and liquidity in exchange for certainty.
For people worried specifically about living into their 90s and running out of money, that trade is often worth making.
Insurance companies can offer this guarantee because they pool risk across thousands of policyholders. Some will die early and collect less than they put in; others will live past 95 and collect far more. The pool balances itself.
Individually, no one knows which side of that equation they will land on which is precisely why the insurance structure makes sense for managing longevity risk.
The Main Types and How They Compare
| Type | Growth Mechanism | Market Risk | Best For |
|---|---|---|---|
| Fixed Annuity | Set interest rate, guaranteed | None | Predictable, conservative income |
| Fixed-Indexed Annuity (FIA) | Linked to a market index (e.g., S&P 500), with a floor | Downside protected (0% floor) | Growth potential without loss risk |
| Variable Annuity | Invested in sub-accounts (mutual fund-like) | Full market exposure | Growth-oriented, higher risk tolerance |
| SPIA (Single Premium Immediate Annuity) | Fixed payout begins within 30 days | None | Immediate income from a lump sum |
| Deferred Income Annuity (DIA) | Fixed payout begins at a future date | None | Longevity insurance for later retirement years |
Fixed-indexed annuities have grown significantly in popularity over the past decade. LIMRA reported that FIA sales reached $105 billion in 2023, a record at the time. They appeal to people who want the possibility of better returns than a CD or savings account but cannot stomach watching their balance drop in a down year.
The 0% floor is not a gimmick, in a year where the linked index falls 20%, the account does not fall at all. The tradeoff is a cap or participation rate that limits upside in strong years, which is a reasonable exchange for many pre-retirees.
Real Numbers: What Does a $250,000 Annuity Actually Pay?
Payouts vary based on age, gender, interest rate environment, and the specific contract terms. As a rough benchmark, based on rates available in 2024 for a 65-year-old purchasing a single premium immediate annuity:
- A $250,000 SPIA for a male age 65 (life only) paid approximately $1,450 to $1,550 per month.
- Adding a joint-life option to cover a spouse reduces that amount to roughly $1,200 to $1,300 per month.
- A 10-year certain-and-life option, which guarantees payments for at least 10 years even if the annuitant dies early, falls between those two figures.
These are real-market estimates based on conditions in 2024, not guarantees for any specific purchaser. Rates fluctuate with interest rate environments. In 2022 and 2023, rising interest rates made annuity payouts significantly more attractive compared to the low-rate environment of 2015 to 2021.
A $250,000 annuity purchased in 2021 would have generated meaningfully less monthly income than the same purchase made in late 2023. Timing and rate environment are real variables, not fine print.
The Accumulation Phase vs. The Income Phase
Not everyone buys an annuity for immediate income. Plenty of people in their 40s and 50s purchase deferred annuities specifically to let money grow tax-deferred before turning on the income stream at 65 or 70.
During the accumulation phase, earnings inside a non-qualified annuity are not taxed until withdrawn, which can be a meaningful advantage for someone in a higher tax bracket who has already maxed out other tax-advantaged accounts like a 401(k) or IRA.
Once income begins, the tax treatment depends on how the annuity was funded. Annuities purchased with after-tax dollars, called non-qualified annuities, are only partially taxable. The IRS uses an exclusion ratio to determine what portion of each payment represents a return of the original principal (tax-free) versus earnings (taxable).
Annuities held inside an IRA or 401(k) are fully taxable upon distribution, the same as any other pre-tax retirement account withdrawal.
This distinction matters for planning. A non-qualified annuity can be a tax-efficient income source in retirement precisely because a portion of each payment is not counted as taxable income, which can help manage adjusted gross income thresholds tied to Medicare Part B premiums and Social Security taxation.
Riders: Where the Customization Happens
An annuity by itself is a relatively simple product. Riders are optional features added to the base contract, usually for an annual fee, that change how the product behaves in specific situations. Some of the most common ones worth understanding:
- Guaranteed Lifetime Withdrawal Benefit (GLWB): Guarantees the ability to withdraw a set percentage, often 4% to 6%, of a “benefit base” each year for life, even if the actual account value hits zero. The benefit base can sometimes grow at a guaranteed rate even in flat markets, which protects future income if withdrawals are delayed.
- Death benefit riders: Ensure that if the annuitant dies before receiving the full account value, heirs receive the remainder rather than the insurance company retaining it. This directly addresses one of the most common objections people raise about annuities.
- Long-term care riders: Allow access to a larger portion of the benefit base if the annuitant requires nursing home or assisted living care, effectively increasing the monthly income during a health event without requiring a separate long-term care policy.
- Cost-of-living adjustment (COLA) riders: Increase income payments annually by a fixed percentage, typically 1% to 3%, to help offset inflation over a long retirement horizon.
Riders add cost, and that cost matters. A GLWB rider might run 0.75% to 1.5% of the benefit base per year. Running the math on whether that cost outweighs the actual benefit given realistic health circumstances and financial needs is a step worth taking with a licensed advisor before committing.
Where Annuities Fit in a Retirement Plan
Most financial planners do not recommend putting every dollar into an annuity. The standard framework is to think of retirement income in layers:
- Guaranteed income covering essential expenses — Social Security plus annuity income
- A liquid investment portfolio for discretionary spending and emergencies
- Supplemental sources such as real estate rental income or part-time work
The annuity typically fills the gap between Social Security and actual monthly expenses. If someone needs $4,000 per month and Social Security pays $2,200, an annuity structured to produce $1,800 per month closes that gap completely.
The rest of the investment portfolio can then be allocated more aggressively because there is no pressure to sell assets during a down market just to pay the electric bill. That dynamic actually gives the total retirement plan more growth potential, not less.
Researchers at the Stanford Center on Longevity and the Society of Actuaries have studied this layered approach extensively. The findings consistently show that retirees who cover essential expenses with guaranteed income report higher financial satisfaction and lower anxiety about money than those who rely entirely on portfolio withdrawals for every dollar they spend.
What to Watch Out For
Annuities are not perfect for every situation, and some products carry costs that do not justify the benefits they provide. The most important things to scrutinize before signing a contract:
- Surrender charges: Most deferred annuities carry surrender periods of 5 to 10 years, during which withdrawing more than a set amount typically 10% per year, triggers a penalty. Putting money into an annuity that might be needed in the short term is a mistake that can be expensive to undo.
- Internal fees: Variable annuities in particular can carry total annual fees of 2% to 3% or more when mortality and expense charges, fund fees, and rider costs are combined. Those fees compound against long-term growth in ways that are easy to underestimate at the point of purchase.
- Insurer financial strength: Annuity guarantees are only as solid as the company backing them. Checking ratings from AM Best, Moody’s, or Standard & Poor’s before purchasing is basic due diligence, not optional. A highly rated insurer in the A range or better is the standard benchmark most advisors recommend.
- Inflation exposure: A fixed payment that feels comfortable at 65 can feel tight at 80 if inflation runs above historical norms for an extended period. COLA riders or keeping a meaningful portion of assets in growth investments addresses this directly without sacrificing the income floor.
Conclusion
For retirees worried about outliving their savings, an annuity is one of the few financial products built specifically to solve that problem by design.
The key is choosing the right structure, understanding all costs involved, and sizing the annuity appropriately within a broader retirement plan that still preserves flexibility and growth potential.