An annuity is a contract where you give an insurance company a lump sum or regular payments, and they promise to pay you a stream of income later

The basic mechanics are straightforward: you hand over money now, the insurance company invests it, and they send you checks on a schedule you choose — monthly, quarterly, or annually. The amount of each check depends on how much you put in, how long you want the payments to last, your age when you start receiving money, and current interest rates. You do not get your original money back as a lump sum; instead, it converts into a series of smaller payments spread over time.

The insurance company keeps whatever money remains after they have paid you out. If you die before the payments end, what happens to the leftover balance depends on the contract terms you chose at the start. Some annuities stop paying entirely; others pass the remainder to your beneficiary. This is why the specific language in your contract matters more than the product name.

Key Takeaways

  • You transfer a sum of money to an insurance company in exchange for regular income payments that begin when ready or at a future date you choose.
  • The size of each payment is locked in based on your age, the amount you invested, how long payments will last, and interest rates at the time you purchase.
  • when ready annuities start paying you within a year; deferred annuities let your money grow for years before payments begin.
  • Your contract specifies whether payments stop when you die or continue to a beneficiary, and this choice directly affects the size of each check.
  • Annuities are insurance products, not investments you can sell or withdraw from without penalties during the payout phase.

when ready annuities: you start receiving payments right away

An when ready annuity begins paying you within 12 months of purchase. You hand over a lump sum — say $200,000 — and the insurance company starts sending you monthly checks the next month or within a few months. The payment amount is fixed the day you buy the contract and does not change, even if interest rates rise or fall later.

This type works well if you have a large amount of money sitting idle and need steady income now. Retirees often use when ready annuities to convert a portion of savings into may provide paychecks they cannot outlive. Because payments start so soon, the insurance company has less time to invest your money, so the monthly check is smaller than it would be if you waited years to start receiving payments.

Deferred annuities: your money grows before payments start

A deferred annuity delays the start of payments — sometimes for decades. You give the insurance company money today, they invest it, and you do not receive checks until a date you specify, such as age 70 or 80. During the waiting period, your balance grows based on the interest rate or investment performance built into your contract.

Deferred annuities appeal to people who do not need income when ready but want to lock in a may provide payment amount for later. Because the insurance company has years to invest your money before they start paying you, the monthly check is larger than an when ready annuity would provide. However, you cannot withdraw the growing balance without penalties during the accumulation phase — the contract is designed to keep the money invested until the payout date arrives.

Fixed versus variable: how your money grows while you wait

A fixed annuity guarantees a specific interest rate for the entire time your money sits with the insurance company. If you lock in 3 percent, you earn 3 percent every year until payments begin, regardless of what happens in the stock market or broader economy. This predictability means you know exactly how large your future payments will be.

A variable annuity ties your balance to investment accounts you choose — typically mutual funds or similar portfolios. Your money grows faster if those investments perform well, but it can shrink if they perform poorly. The insurance company guarantees a minimum payment amount, but the actual check could be larger if your investments outperformed expectations. Variable annuities carry more risk and more potential reward than fixed annuities.

Single life, joint life, and period certain: who gets paid and for how long

The payout structure you choose determines how long the insurance company will send checks and who receives them. These choices are locked in when you purchase the annuity and cannot be changed later.

Single life annuity pays you for as long as you live, then stops. The monthly check is the largest of all options because the insurance company is betting you will not live extremely long. If you die at 75, they keep the remaining balance. If you live to 105, they keep paying you. This option leaves nothing for heirs.

Joint and survivor annuity continues paying your spouse or designated beneficiary for their lifetime after you die. The monthly check is smaller than single life because the insurance company expects to pay for two lifespans instead of one. This protects your surviving spouse from losing income.

Period certain annuity guarantees payments for a fixed number of years — say 10 or 20 years — regardless of whether you are alive. If you die after 5 years, your beneficiary receives the remaining 5 years of payments. If you live past the period, payments stop. The monthly check falls between single life and joint survivor options.

What happens to your money during the payout phase

Once the insurance company starts sending you checks, part of each payment is a return of your original money and part is earnings or interest. The IRS taxes only the earnings portion if you bought the annuity with after-tax dollars. If you bought it with pre-tax money from a retirement account, the entire check is taxable as ordinary income.

You cannot access the remaining balance as a lump sum once payments have started. The contract converts your money into a stream of payments, and that conversion is permanent. Some annuities allow you to withdraw a small percentage each year without penalty, but most lock the money in until the payout schedule ends or you die.

Costs and surrender charges: what it costs to change your mind

Annuities often include surrender charges — penalties for withdrawing money before a set date, typically 5 to 10 years after purchase. If you need your money back early, the insurance company deducts a percentage of your balance, sometimes 5 to 10 percent or more depending on how many years remain in the surrender period. This is why annuities are long-term commitments.

Variable annuities typically charge annual fees for managing the investment accounts, often 0.5 to 2 percent of your balance per year. Fixed annuities usually have no explicit annual fees, but the insurance company builds their profit into the interest rate they offer you. Always ask for a complete fee schedule before you buy, because fees compound over decades and significantly reduce your final payout.

Frequently Asked Questions

Can I get my money back if I change my mind?

Most annuities have a free look period of 10 to 30 days after purchase during which you can return the contract and get your full money back. After that period ends, early withdrawal triggers surrender charges that can be substantial. Once the payout phase begins, you cannot get a lump sum refund — you receive only the scheduled payments.

What if I die before the annuity starts paying me?

If you die during the accumulation phase of a deferred annuity, your beneficiary receives the balance you built up, either as a lump sum or as continued payments depending on your contract. If you die after payments have started, what your beneficiary receives depends on the payout option you selected — single life pays nothing to heirs, while joint survivor or period certain options continue payments.

How is annuity income taxed?

If you bought the annuity with after-tax money, only the earnings portion of each check is taxable. If you bought it with pre-tax retirement account funds, the entire payment is taxable as ordinary income. The insurance company sends you a 1099-R form each year showing the taxable amount. Taxes are due when you receive the payment, not when you originally invested the money.

Can I change the payment amount after I start receiving checks?

No. Once the payout phase begins, the payment amount is fixed for the life of the contract. You cannot increase or decrease the monthly check, switch to a different payout schedule, or convert back to a lump sum. This is why choosing the right payout structure before you buy is critical.

What is the difference between an annuity and a pension?

Both provide regular income, but a pension is funded and managed by an employer, while an annuity is a contract you purchase from an insurance company with your own money. Pensions are typically free to the employee; annuities require you to pay the full cost upfront. Pensions are rare outside government and some large corporations, while annuities are available to anyone with savings.