Types of Annuities and Their Pros and Cons
By Hans Goldstein, founder, Retirement Literacy Foundation · Updated
Side by side
| Type | How it grows or pays | Main trade-off |
|---|---|---|
| Fixed / MYGA | Declared interest rate for a set term | Money is tied up for the term; rate is fixed even if rates rise |
| Fixed indexed | Interest linked to an index, limited by a cap or participation rate, 0% floor | Upside is capped and caps can be reset by the insurer |
| Variable | Invested in sub-accounts; value moves with markets | Market risk and higher annual fees |
| Immediate (SPIA) | Lump sum becomes income now, for life or a period | Usually irrevocable; little or no access to the lump sum |
| Deferred income / QLAC | Income that starts years later | Money locked until income starts |
Pros
- Tax deferral outside retirement accounts, with no contribution limit.
- Guarantees: a guaranteed rate, protection from market losses, or income you cannot outlive.
- Longevity insurance: income annuities pay more the longer you live.
- Probate: a named beneficiary receives the death benefit directly.
Cons
- Access: surrender charges in the early years. See surrender charges.
- Ordinary income tax on gains instead of capital gains rates, and the 10% extra tax before 59½. See how annuities are taxed.
- No step-up for heirs. See inherited annuity taxes.
- Complexity and costs: riders, caps and fees can be hard to compare, and sales commissions are built in. See annuity commissions.
- Insurer credit risk, backed up only to limits by state guaranty associations.
Annuity vs CD, and annuity vs 401(k)
Versus a CD: a multi-year guaranteed annuity works like a CD from an insurer. It often pays a somewhat different rate, defers tax until withdrawal (a CD's interest is taxed every year), is not FDIC insured, and penalizes early withdrawals through a surrender charge. See the MYGA vs CD spread index.
Versus a 401(k): a 401(k) gets pre-tax contributions and often an employer match, which an annuity cannot offer. Annuities are typically considered after retirement accounts are maxed out, or for rolling over part of a 401(k) to buy guarantees.
Common questions
What is the safest type of annuity?
Fixed and multi-year guaranteed annuities have the most predictable value because the rate is declared in advance. All annuity guarantees depend on the insurer's ability to pay.
What are the disadvantages of annuities?
Limited access during the surrender period, ordinary income tax on gains, a 10% extra tax before 59 1/2, no step-up for heirs, built-in costs and insurer credit risk.
Is an annuity better than a CD?
Neither is better in general. An annuity defers tax and can lock a rate for longer; a CD is FDIC insured and usually more liquid. It depends on your tax bracket, time horizon and need for access.
Related
- How annuities work
- FIA minimum caps study
- Living benefit riders
- MYGA vs CD spread index
- All annuity education pages
More on annuities: How Do Annuities Work? A Plain-English Guide · How Are Annuities Taxed? · Inherited Annuity Taxes · 1035 Exchange · Annuities in an IRA · Annuity Surrender Charges and How to Get Out of an Annuity · What Is a MYGA? Multi-Year Guaranteed Annuities Explained · Fixed Index Annuity Explained · Immediate Annuity (SPIA) Explained · Variable Annuity Explained · Annuity vs CD
Education only; nothing is sold here and no product is recommended. Hans Goldstein, founder of the Retirement Literacy Foundation, is also a licensed California insurance producer (#4273294). Tax rules depend on your situation; check with a tax professional before acting.