Understanding Annuities: A Complete Guide to Fixed, Variable, and Indexed Annuities
I’m often asked what I think about annuities. That’s a hard question to answer—because it’s like asking what I think about fruit. There are way too many kinds to generalize and say they’re all good or all bad.
Now that the SECURE Act has pushed lifetime-income concepts and annuity options further into workplace retirement plans, it’s more important than ever to understand the basics—especially if you’re seeing new “guaranteed income” features in a 401(k) statement.
I could write a whole book about annuities and still not cover everything. So instead, this article is designed to do two things:
Give you a clear, practical overview of the main annuity types and “moving parts.”
Answer the most common annuity questions with the real-world caveats that matter.
What is an annuity?
An annuity is a contract with an insurance company. In exchange for your money (either a lump sum or a series of deposits), the insurer promises some combination of:
Tax-deferred growth (in many cases)
Income you can’t outlive (if you choose lifetime payout features)
Principal protection or downside limits (in some products)
Optional “riders” (extra features—usually for an extra cost)
Annuities can live in retirement accounts (like a 401(k) or IRA) or be purchased with after-tax money (a “non-qualified” annuity). The tax rules differ depending on where the annuity sits.
Why the SECURE Act made annuities more visible inside 401(k)s?
The SECURE Act didn’t force anyone to buy an annuity—but it did make annuity/lifetime income features easier to discuss and implement in employer plans:
Lifetime income illustrations on benefit statements (showing what your balance might translate into as monthly income).
A fiduciary safe harbor to help plan fiduciaries evaluate and select insurers for guaranteed income contracts (reducing a major barrier).
Portability rules that can allow participants to move certain lifetime income investments if the plan removes that option.
In other words: more people now see the annuity conversation earlier—sometimes years before retirement.
The three main annuity types (and what they really mean)
You’ll often hear annuities grouped into three buckets:
1) Fixed annuity
You give an insurance company money. In return, they promise a fixed rate (during accumulation) and/or fixed payments (during payout), depending on the contract structure.
Common use case: “Bond-like” stability, predictable income planning.
2) Variable annuity
Your money is invested in sub-accounts (similar to mutual-fund-like portfolios). Your value and/or income can rise or fall based on market performance.
Variable annuities can be complex and fee-heavy; regulators explicitly warn investors to understand the full fee stack.
Common use case: Someone wants tax deferral + investment exposure + optional guarantees (via riders)—and understands the tradeoffs.
3) Indexed annuity (often “Fixed Indexed Annuity,” FIA)
You give an insurance company money. They offer a floor (often 0% annual crediting, not negative) and a formula tied to an index (like the S&P 500) that determines how much interest gets credited. The index linkage is not the same as owning the index.
Common use case: “I want upside potential with guardrails,” typically in exchange for caps/participation limits and a surrender period.
Immediate vs. deferred: when do payments start?
Regardless of type, an annuity is usually described by when income begins:
Immediate: payments start within 12 months of purchase
Deferred: payments start later than 12 months from purchase
Deferred annuities often have two phases:
Accumulation phase (you grow value)
Income phase (you turn it into cash flow)
Payout choices: how long does income last?
You can usually choose income that lasts:
For life (single life)
For both spouses (joint life / survivor options)
For a set number of years (period certain, e.g., 10 years)
Or a hybrid (life with a minimum period certain)
Riders: the “bells and whistles” (and what they cost)
Riders are add-ons that can change outcomes dramatically. Common categories:
Income riders (e.g., guaranteed lifetime withdrawal benefit)
Death benefit riders (enhanced beneficiary protection)
Inflation options (less common, can be expensive)
Long-term-care-related riders (varies by insurer/structure)
Important: riders aren’t automatically “bad”—but they’re rarely free.
Here are the most common questions—plus the missing context that matters.
1) “Are annuities worth it?”
Better question: What risk are you trying to solve?
Annuities can be useful when you need:
A paycheck you can’t outlive
A plan for longevity risk (living longer than expected)
A way to add stability to a portfolio that’s otherwise market-dependent
They tend to disappoint when someone expects them to act like a low-cost index fund and a perfect insurance policy at the same time.
2) “What are the pros and cons of annuities?”
Pros (when used well):
Can create lifetime income
Can provide guardrails (principal protection or buffered outcomes in some designs)
Can add structure to spending plans
Cons (when used poorly):
Complexity (hard to compare apples-to-apples)
Fees and limits
Surrender charges / reduced liquidity for a period of time
Guarantees are only as strong as the claims-paying ability of the insurer
3) “How are annuities taxed?”
This depends on whether the annuity is qualified (inside IRA/401(k)) or non-qualified (after-tax money).
For many non-qualified annuities, withdrawals are generally treated as coming from earnings first (taxable) and then principal (your basis).
The earnings are taxed as ordinary income.
Tax rules get nuanced fast—especially with partial withdrawals, annuitization choices, and legacy contracts.
4) “What fees should I look for?”
A practical way to do this is to ask for an all-in cost summary and confirm:
Surrender period and surrender schedule
Ongoing rider fees (if any)
For variable annuities: contract fees + underlying investment expenses + rider fees
Whether there are premium bonuses (and what tradeoffs come with them)
5) “What is a surrender charge—and how long does it last?”
A surrender charge is a cost for exiting early. Many contracts have schedules that start higher and decline over time; some can be substantial in early years.
6) “Fixed indexed annuity: how does the index part work?”
Key point: You typically don’t own the index. You have a crediting method tied to index performance, often with:
Caps (maximum credited interest)
Participation rates (percentage of index gain credited)
Spreads (a deduction from index gain)
You’re trading unlimited upside for downside limits and insurance guarantees. That’s not inherently bad—it’s just a trade.
7) “Variable annuity: why do people say fees are high?”
Because fees can stack: base contract + mortality & expense + administration + fund expenses + optional riders + surrender charges.
Sometimes a variable annuity is still appropriate—but the only honest way to judge is to compare:
Expected benefits you actually plan to use
vs.Total costs and restrictions you must accept
8) “Should I roll my 401(k) to an annuity?”
This is highly situation-dependent. A useful framework is:
What guaranteed income sources do you already have (Social Security, pension)?
Do you need more income floor or more flexibility/liquidity?
Are you comfortable with market risk at your retirement date?
What is the cost of the guarantee?
The SECURE Act also means some people will encounter lifetime-income options inside the plan (not only after a rollover).
9) “Is my annuity protected like FDIC insurance?”
No—annuities are not FDIC-insured.
There are state guaranty associations that may provide limited protection if an insurer fails, but coverage limits vary by state and by category (often cited in the industry around “$250,000 present value of annuity benefits,” but you must check your state’s rules).
10) “Can I do a 1035 exchange to a better annuity?”
A Section 1035 exchange can allow a tax-free exchange of one annuity for another annuity in certain situations, but details matter (including ownership consistency and how the exchange is structured).
Also: a 1035 exchange doesn’t automatically erase surrender charges—you still need to check whether you’re giving up value to move.
Disclaimer: This article is for educational purposes only and is not individualized investment, tax, legal, or insurance advice. Product availability, features, and rules vary by carrier, state, and contract.