What a fixed annuity does

A fixed annuity is a contract between you and an insurance company where you give them a lump sum of money (or make payments over time), and in return they promise to pay you a set amount at regular intervals — usually monthly or annually — for a period you choose or for the rest of your life. The insurance company guarantees both the payment amount and when you receive it, which is why it is called "fixed."

The core appeal is predictability. Unlike stocks or bonds, where your payment depends on market performance, a fixed annuity removes that uncertainty. You know exactly what you will receive each month. The insurance company takes on the investment risk and longevity risk — the risk that you live longer than expected — and they price the contract to cover those risks and their own profit.

Fixed annuities are most common among people nearing or in retirement who want to convert savings into may provide income. They are not investments in the traditional sense; they are insurance products that trade growth potential for certainty.

Key Takeaways

  • You pay the insurance company a sum of money upfront, and they promise to pay you a fixed amount at regular intervals for a set period or your lifetime.
  • The payment amount is locked in when you buy the annuity and does not change based on market performance or inflation.
  • Your money grows tax-deferred inside the annuity, meaning you do not pay income tax on the growth until you withdraw it.
  • Most fixed annuities have surrender charges if you withdraw money in the first 5 to 10 years, so they work best as long-term commitments.
  • The insurance company's financial strength matters because they are the one making the promise to pay you, not a government agency.

How the payment amount is determined

When you buy a fixed annuity, the insurance company calculates your payment based on three main factors: how much money you give them, your age when you start receiving payments, and how long you want the payments to last.

If you are older when you start, your monthly payment will be higher because the insurance company expects to pay you for fewer years. A 75-year-old buying a lifetime annuity receives more per month than a 65-year-old with the same initial investment. If you choose payments for a fixed number of years — say, 20 years — rather than for life, your monthly payment is also higher because the company's obligation ends after that period.

The insurance company also factors in current interest rates. When rates are high, they can earn more on your money, so they can afford to pay you more. When rates are low, your payments are lower. This is why the same annuity purchased in different years produces different monthly amounts.

Tax treatment and how money grows inside the annuity

Money inside a fixed annuity grows tax-deferred, meaning you do not owe income tax on the growth each year the way you would with a regular savings account or taxable investment account. If the insurance company earns interest on your money, that interest compounds without being taxed annually.

However, when you start taking payments, part of each payment is considered a return of your original investment (which is not taxed) and part is considered earnings (which is taxed as ordinary income). The insurance company provides a calculation showing how much of each payment is taxable. If you bought the annuity with pre-tax money from a retirement account like a traditional IRA, the entire payment is taxed as ordinary income.

If you withdraw money before your scheduled payment date — or if you want to access a lump sum before the annuity "matures" — you may owe income tax on the earnings portion plus a surrender charge, which is a penalty the insurance company imposes for early withdrawal. Surrender charges typically decline over time and disappear after 5 to 10 years, depending on the contract.

when ready annuities versus deferred annuities

A when ready annuity (also called a single-premium when ready annuity, or SPIA) begins paying you within a year of purchase. You hand over a lump sum, and the payments start almost right away. These are common for people who have just retired and want to convert a portion of savings into may provide income when ready.

A deferred annuity has two phases: an accumulation phase where your money grows tax-deferred, and a payout phase that begins later — sometimes years or decades later. You might buy a deferred annuity at age 55 and not start receiving payments until age 70. During the accumulation phase, your money earns a may provide rate of return set by the insurance company. Deferred annuities appeal to people who want to lock in a rate now but do not need the income yet.

What happens to your money if you die

The terms depend on the type of annuity you choose. A life annuity pays you for as long as you live, but if you die before the insurance company has paid out the full amount you invested, the remaining balance typically stays with the insurance company. This is how they manage longevity risk.

Many people find this unacceptable, so they choose a period-certain annuity or a life with period-certain annuity. A period-certain annuity guarantees payments for a set number of years (say, 20 years), and if you die before that period ends, your beneficiary receives the remaining payments. A life with period-certain annuity pays you for life, but guarantees a minimum of, for example, 10 years of payments — so if you die after 5 years, your beneficiary gets 5 more years of payments.

These options reduce your monthly payment because the insurance company's risk is lower, but they provide peace of mind that your heirs will receive something if you die early.

Surrender charges and access to your money

Most fixed annuities lock your money in for a period called the surrender period, typically 5 to 10 years. If you withdraw money beyond a small annual amount (often 10 percent) during this period, you pay a surrender charge — usually a percentage of the amount withdrawn, starting high and declining each year.

For example, a contract might have a 7 percent surrender charge in year one, declining by 1 percent each year until it reaches zero in year 8. If you withdraw $50,000 in year two and the charge is 6 percent, you owe $3,000 to the insurance company on top of any income taxes owed on the earnings portion.

This structure is why fixed annuities work best as long-term commitments. If you think you might need access to your money within the next several years, the surrender charges can be expensive. Some contracts allow you to withdraw a small percentage each year without penalty, and some offer a "free look" period (usually 10 to 30 days) where you can return the contract and get your money back.

Comparing fixed annuities to other retirement income sources

A fixed annuity is one way to create may provide income, but it is not the only way. Social Security provides may provide, inflation-adjusted income for life, but you cannot control the amount and you must wait until a certain age to claim it. A pension (if you have one) also provides may provide income, but you do not own the underlying money — the employer or pension fund does.

A fixed annuity gives you control over how much money to convert and when to start payments, but in exchange you give up access to that money and you accept that payments do not increase with inflation (unless you buy an inflation-adjusted rider, which reduces your monthly payment). Bonds and bond funds provide income without locking your money away, but the income is not may provide and the principal can fluctuate.

Many financial advisors suggest using annuities for a portion of retirement savings — enough to cover essential expenses — while keeping other money in investments that can grow or provide flexibility. This approach balances certainty with opportunity.

Frequently Asked Questions

Can I change my mind after I buy a fixed annuity?

Most states require a "free look" period of 10 to 30 days after purchase during which you can return the contract and receive a full refund. After that period ends, you are locked in. If you withdraw money during the surrender period, you pay surrender charges and income taxes on earnings. Some contracts allow penalty-free withdrawals of a small percentage each year.

What if the insurance company goes out of business?

Each state has a guaranty fund that protects annuity holders if an insurance company fails. The coverage limit varies by state but is typically $100,000 to $250,000 per person per company. This is why the financial strength of the insurance company matters — check ratings from agencies like A.M. Best or Moody's before buying.

Do fixed annuities protect against inflation?

No. Your monthly payment stays the same for the life of the contract, so inflation erodes its purchasing power over time. Some annuities offer an inflation rider that increases your payment by a set percentage each year, but this reduces your starting payment. Without a rider, a $2,000 monthly payment in 2024 buys less in 2034.

Can I use a fixed annuity inside a retirement account like an IRA?

Yes, you can buy a fixed annuity inside a traditional IRA, Roth IRA, or other retirement account. The tax-deferral benefit of the annuity is redundant inside a retirement account (which is already tax-deferred), so you are mainly paying for the may provide income feature. Withdrawals from a traditional IRA annuity are taxed as ordinary income; Roth withdrawals are tax-free if certain conditions are met.

What is the difference between a fixed annuity and a variable annuity?

A fixed annuity pays a may provide amount regardless of market performance. A variable annuity lets you choose how your money is invested (usually in mutual funds), so your payment depends on how those investments perform. Variable annuities carry market risk but offer growth potential; fixed annuities trade growth for certainty.