HomeInsuranceHow Do They Work, Types And More

How Do They Work, Types And More

If you’re nearing retirement, one of the most important (and potentially stressful) questions you have to ask yourself is “do I have enough?”

One-third of Americans over 50 said their biggest retirement planning regret was not obtaining a lifetime income source, according to a Nov. 2022 study from researchers at the University of Pennsylvania and the Hebrew University of Jerusalem. 

One way to help maintain a regular income during retirement is by buying annuities. These are complicated products that can come with high fees, but CNBC Select explains the basics so you can decide if annuities are worth a closer look.

What is an annuity?

An annuity is a contract between an investor and an insurance company. The investor, known as the annuitant, pays either a lump sum or a series of payments to the insurance carrier in exchange for guaranteed income payments, which can begin immediately or in the future. You can buy an annuity from insurance companies, banks, brokerage firms and online issuers.


Let’s imagine a 40-year-old woman invests a lump sum of $50,000 into a fixed annuity. She elects to begin receiving payments from that annuity when she is 65-years-old. Even if she adds no additional benefits to her annuity contract, she will receive upwards of $900 per month for the rest of her life after she turns 65.

How do annuities work?

How do you get paid with an annuity?

How much can you expect in returns?

Annuity investment returns depend on a number of factors, including the performance of the index it’s invested in, the cap on potential interest it can earn, the type of annuity and more. But you can usually expect to see a 4% – 6% annual return on some annuities and as much as an 8% annual return on others. So, if these investments are left alone for extended periods, they can be extremely lucrative in retirement.

Different types of annuities have varying levels of risk, but annuities as a whole can typically withstand economic downturns. Of course, every investment comes with some sort of market risk, but you can reduce that risk by adding a rider to your annuity contract (for an additional cost), which can protect you from the losses of the annuity investment underperforming.

These benefits can make annuities a safer investment than owning common stock for example, but the more lucrative your annuity’s benefits (or riders) the more expensive your annuity’s fees will be.

Do you pay fees on annuities?

An annuity fee is an additional cost associated with purchasing an annuity. These fees are usually deducted from the balance of your investment. Annuity fees typically run between 1% and 3% of your account’s balance annually. 

The types of fees you encounter depend on the company you purchase the annuity fee from. Some companies, like USAA, charge no upfront fees except the 10% IRS penalty for those who make withdrawals before age 59½. Some companies charge fees that may be administrative, like commission fees and maintenance fees.

Make sure you understand and are financially prepared for the fees associated with an annuity before purchasing it. The more complicated an annuity, the more expensive its fees are. For example, a variable annuity, which requires more investor oversight, will typically cost more than a simple fixed annuity.

However, the most common fees are charged for optional benefits called annuity riders.

USAA Annuities

  • Types offered

  • Fees

  • Minimum

    Minimums range from $20,000 to $50,000 to open a Fixed Guaranteed Growth annuity, and the minimum to open a single premium immediate annuity is $20,000.

  • Educational resources

    USAA offers Retirement Income Specialists who can provide complimentary retirement income planning.

What is an annuity rider?

Annuity riders are like add-on benefits that can be purchased and are separate from the base contract that you sign when you take on an annuity. By paying an additional fee, you can eliminate some of the risks associated with annuities and make them a more attractive investment.

Switzer says examples of annuity riders include

  • An enhanced death benefit: This could make your contract pay out the maximum of its value when you die. 
  • A guaranteed minimum income: This prevents your income from dropping below a certain threshold regardless of what type of annuity it is. This rider might guarantee that you will receive a payment based on the value of your initial investment compounded at 6% interest annually, at minimum, or it might guarantee that you receive a payment based on the highest market value that your investment ever achieved.
  • A guaranteed lifetime withdrawal benefit: This allows you to have access to your account value at all times, bypassing a deferral period and letting you use your annuity account as an emergency fund. 

Certain companies offer other benefits like long-term care riders that match payments for medically required long-term care, a cost-of-living rider that adjusts your payments for inflation, or an impaired risk rider that can essentially fast-track your annuity payout should you be given a life-shortening diagnosis. 

It’s important to remember that (in general) the more value a rider adds to your annuity, the more expensive it will be.

What are the different types of annuities?

Annuities come in many shapes and sizes. Some are purchased as a one-time payment, and some are purchased through a series of payments. Annuities also vary in how they pay out, with some giving you a lump sum while others make a series of payments. 

Evan Potash, an executive wealth management advisor at TIAA, says there are two general categories of annuities: immediate annuities and deferred annuities. 

  • Immediate annuities are opened with a lump sum investment and result in immediate, guaranteed income payments. These are sometimes referred to as income annuities. These are smart investments for late savers or those close to (or already in) retirement, since they start paying out immediately. However, unlike deferred annuities, they don’t have as much time to accumulate interest, so payments are usually lower.
  • Deferred annuities, by contrast, have a deferral period that focuses on wealth accumulation before payout. This is the most common category of annuities, especially for those saving for retirement. This allows your capital investment more time to accrue interest, resulting in higher payments than an immediate annuity would. Think of deferred annuities like a private form of social security. And unlike immediate annuities, these annuities usually offer a death benefit, which transfers your remaining assets to a beneficiary should you die before the end of the annuity contract. However, deferred annuities have long surrender periods, making your investment non-liquid usually for two to eight years.

Regardless of whether an annuity plan is immediate or deferred, Potash says an annuity can be structured in one of three ways: as a fixed, variable or indexed annuity. Some companies, like Fidelity, offer all three types of annuities and have financial advisors who can help you choose which is best for you.

Fidelity Annuities

  • Types offered

  • Fees

    Depending upon the plan, fees can range from around 0.25% to 1.9%. If you invest more than $1 million in a Fidelity Personal Retirement Annuity® then the fee can be as low as 0.10%. These are relatively low fees in comparison to other fees on the annuity market.

  • Minimum

    Depending upon the plan, the minimum investment ranges from $5,000 to $50,000.

  • Educational resources

    Fidelity offers a team of financial professionals that can assist you with planning and advice, and access to The Fidelity Insurance Network® which helps you compare products from reputable providers who offer competitive products. Fidelity also offers several tools that can help you determine what annuity best suits you.

What is a fixed annuity?

A fixed annuity is one that delivers you payments with a flat rate of return, regardless of inflation or market changes. While fixed annuities provide peace of mind and typically have little-to-no fees attached, they usually don’t pay out as much money as a variable annuity. 

What is a variable annuity?

A variable annuity gets invested in stock funds that typically keep pace with inflation – think real estate or bond funds. With variable annuities, you can assume that these investments will keep your cash as valuable as or more valuable than it was when you first invested it. 

With this type of annuity, you run the risk of the market going down and your monthly payment decreasing. While you will contractually receive payments for life, they may decrease substantially, and it may take decades for your payments to equal your initial investment.

“You’re not going to run out of money, but it can continue to go lower if the market continues to go lower,” says Potash. “But over the long term, if you look at markets, they tend to go up much more than they go down.”

If you opt for a variable annuity, you should have a backup plan or a flexible budget so you can still afford all your expenses in case your payouts decrease over time.

What is an indexed annuity?

An indexed annuity is one that is invested in indexes, like the S&P 500 or the Dow Jones. Because these stocks represent a considerable number of America’s top companies, they generally reflect the economy as a whole. Like a variable annuity, an indexed annuity is designed to keep pace with inflation and secure your purchasing power for life.  

But indexed annuities are not foolproof. You’re likely to have lower returns than you would with a fixed annuity should you encounter a bad market year, as your investment is exposed to an index stock or index-linked bond. However, this type of annuity usually guarantees that the least amount of interest you can earn annually is 0%. So if the index goes up, you’ll earn a percentage of those gains and if the index goes down, you may not earn anything — but you also won’t lose any of the money you put in the annuity.

When are annuities a good investment?

Should I rely solely on annuities for retirement?

Switzer says annuities are best as one component of an entire retirement portfolio, and you should not invest everything you have saved into annuities. 

“Annuities can really just be another investment vehicle, and it’s an investment that has some guarantees, and that can work very well for some people,” says Switzer.

Investing all of your retirement savings into annuities leaves you with a lump sum of potentially interest-accruing value, but you can’t access a majority of it at once. If you encounter a financial emergency and need lots of cash quickly, you will likely be out of luck. 

Potash recommends having about a third of your savings readily accessible and about two-thirds of your money in a guaranteed account of some kind, like an annuity, pension or social security.

What other options do I have for retirement?

There isn’t one right way to fund your retirement. Depending on your employer, your income and your lifestyle, you have plenty of options for smartly saving for your golden years. 

Employer-sponsored plans include 401(k) and 403(b) accounts, which are tax-advantaged retirement plans. Roth 401(k)s are slightly different, as they’re an employer-sponsored after-tax plan. 

Individual plans include IRAs, Roth IRAs and simple IRAs. These investing tools allow individuals to earmark their retirement savings by making individual contributions. These plans are not tied to your employer, so anyone can open an individual retirement account. Further, you don’t have to pay taxes on withdrawals from Roth IRAs since you’ve paid taxes upfront.

For unsure retirement investors, CNBC Select recommends robo-advisors like Betterment and Wealthfront, which allow you to indicate factors like risk tolerance, time horizon and financial goals so the platform can invest your money in a portfolio that aligns with your needs. These platforms make it easy to invest your money on auto-pilot and prepare for retirement in a hands-off manner.


  • Minimum deposit and balance

    Minimum deposit and balance requirements may vary depending on the investment vehicle selected. For example, Betterment doesn’t require clients to maintain a minimum investment account balance, but there is a ACH deposit minimum of $10. Premium Investing requires a $100,000 minimum balance.

  • Fees

    Fees may vary depending on the investment vehicle selected. For Betterment Digital Investing, 0.25% of your fund balance as an annual account fee; Premium Investing has a 0.40% annual fee

  • Bonus

    Up to $5,000 managed free for a year with a qualifying deposit within 45 days of signup. Valid only for new individual investment accounts with Betterment LLC

  • Investment vehicles

  • Investment options

    Stocks, bonds, ETFs and cash

  • Educational resources

    Betterment offers retirement and other education materials

Terms apply. Does not apply to crypto asset portfolios.


  • Minimum deposit and balance

    Minimum deposit and balance requirements may vary depending on the investment vehicle selected. $500 minimum deposit for investment accounts

  • Fees

    Fees may vary depending on the investment vehicle selected. Zero account, transfer, trading or commission fees (fund ratios may apply). Wealthfront annual management advisory fee is 0.25% of your account balance

  • Bonus

  • Investment vehicles

  • Investment options

    Stocks, bonds, ETFs and cash. Additional asset classes to your portfolio include real estate, natural resources and dividend stocks

  • Educational resources

    Offers free financial planning for college planning, retirement and homebuying

If you are self-employed or work freelance, you should consider an SEP (simplified employee pension) plan, which may also have provisions for guaranteed lifetime income. 

You could also consider investing your money in a high-yield savings account or investing in stocks and bonds.

Regardless of how you prepare for retirement, you should still maintain cash reserves separate from investments. Having a diverse portfolio, one that includes a sure-fire cash tap, is always a smart approach to retirement.

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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.

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