Pensions, annuities and insurance
Annuities explained
The main kinds of annuity, what income annuities do for a retirement plan, how they're taxed, what they cost, and how to test one before you buy.
Education, not advice. This guide explains general rules with invented examples. It isn't financial, tax or legal advice for your situation. Tax figures are for 2026 and come from published IRS, SSA and CMS sources. Rules change, so check current figures before you act.
An annuity is a contract with an insurance company. You pay money in, and the insurer promises payments back, either now or later. The word covers very different products. Some are simple income contracts. Others are complex investments with layers of fees.
This guide sorts them out, then focuses on the kind most useful to retirees: the income annuity.
The main kinds
| Kind | What you get | Main use |
|---|---|---|
| Immediate income annuity | Payments for life starting within a year | Turn savings into a pension-like check |
| Deferred income annuity | Payments for life starting years later | Insurance against a very long life |
| Fixed (multi-year) annuity | A set interest rate for a set term | A CD-like alternative, with tax deferral |
| Fixed indexed annuity | Interest tied to a market index, with a floor and a cap | Some market upside without losses |
| Variable annuity | Investments in subaccounts, often with optional benefit riders | Tax-deferred investing, sometimes with income riders |
Fixed, indexed and variable annuities are mainly ways to save. Income annuities are a way to spend. They're the kind this guide covers in most detail.
How an income annuity works
You hand an insurer a lump sum. It pays you a fixed amount every month for as long as you live. When you die, payments stop, unless you chose a joint-life contract or a period-certain option.
This sounds like a bad deal if you die early, and it is. That's the point. The money left by people who die early pays for the people who live long. These are called mortality credits. They let an income annuity pay more than you could safely withdraw from the same savings on your own.
Payout rates depend on your age, interest rates, whether the contract covers one life or two, and any extras. Older buyers get higher payouts, because the insurer expects to pay for fewer years.
Options that lower the check
- Joint life. Payments continue while either spouse is alive.
- Period certain. Payments continue to heirs for at least a set number of years.
- Cash refund. Heirs receive any part of the premium not yet paid out.
- Yearly increases. Payments rise by a set percentage each year.
Each option makes the starting check smaller. A fixed yearly increase helps against inflation, but it isn't an inflation guarantee.
A worked example
Carmen is 67 and single. She has $600,000 saved, and Social Security pays her $2,200 a month. Her essential spending is $4,000 a month. The rest of her budget is travel and gifts she could cut if she had to.
Suppose an insurer quotes her $575 a month for life for each $100,000, with no refund or increases. That's a payout rate of 6.9% a year.
To cover the $1,800 a month gap in her essentials, she would need about $313,000. That would leave $287,000 invested for flexible spending and emergencies.
| Without an annuity | With a $313,000 annuity | |
|---|---|---|
| Guaranteed income each month | $2,200 | $4,000 |
| Invested savings | $600,000 | $287,000 |
| Essentials covered by guaranteed income | 55% | 100% |
With the annuity, a market crash can't stop her paying for essentials. The trade-offs are real, though. She gives up access to $313,000. Her heirs get none of it if she dies early. The $1,800 doesn't rise with prices, so its buying power shrinks each year.
Some retirees split the difference. They annuitize a smaller share now, or buy a deferred annuity that starts at 80 or 85, when outliving savings becomes a bigger worry.
What annuities cost
Income annuities have no yearly fee you can see. The costs are built into the payout rate. Comparing quotes from several insurers is the main way to keep costs down.
Variable and indexed annuities are different. Their fees can include:
- mortality and expense charges
- investment fees inside each subaccount
- rider fees for income or death benefits
- surrender charges if you withdraw early, sometimes for seven years or more
Indexed annuities credit interest using formulas with caps and participation rates. Read how the crediting works before comparing one with a plain investment.
How annuities are taxed
The tax depends on where the money came from.
Inside an IRA or 401(k) (qualified). Every payment is taxed as ordinary income, just like any other withdrawal from the account. Required minimum distribution rules still apply, though annuity payments can count toward them.
With after-tax money (non-qualified). Part of each payment is a return of your own premium, and that part isn't taxed. The IRS spreads your premium over your expected payments with an exclusion ratio. Once you've received all your premium back, the rest is fully taxable.
Earnings withdrawn from a deferred annuity before age 59.5 may face a 10% additional tax, with some exceptions. Gains in an annuity are taxed as ordinary income, not at capital gains rates.
Who stands behind the promise
An annuity's guaranteed payments depend on the insurer paying. Check the insurer's financial strength ratings. Every state also has a guaranty association that covers annuity owners up to a limit if an insurer fails. Limits vary by state. Spreading large purchases across insurers keeps each one under the limit.
When an income annuity can make sense
- Your guaranteed income from Social Security and pensions doesn't cover your essential spending.
- You're in good health and your family tends to live long.
- You'd find it hard to keep spending through a market fall.
- You don't plan to leave all your savings to heirs.
It makes less sense if your guaranteed income already covers essentials, if your health is poor, or if you might need a large sum soon. Delaying Social Security is also a way to buy more inflation-adjusted lifetime income, often at a lower cost than an annuity. See when to claim Social Security.
How the app handles annuities
Enter an income annuity's payments as income in your plan, with the type set to Annuity. Choose when payments start, whether they rise each year, and when they end. For a joint-life contract, set the share that continues to a surviving spouse. After the owner's death, the plan keeps paying that share.
Annuity income is taxed as ordinary income. If part of each payment is a tax-free return of after-tax premium, enter that part as a separate income of type Other, marked as not taxable. A deferred annuity that hasn't started paying can be held as an account of type Annuity on the Accounts screen.
To test a purchase, make a scenario that lowers an account by the premium and adds the annuity income. Scenarios run on the same simulated markets as your plan, so you see the effect on your chance of success and on the money left to heirs. The Spending strategies screen also has a "safe floor with upside" strategy. It builds a spending floor from guaranteed income and safe assets, then spends the rest more flexibly.
Frequently asked questions
Is an annuity the same as a pension?
An income annuity works like a pension. The difference is who pays: a pension comes from an employer's plan, an annuity from an insurer you choose.
Can I get my money back?
From an income annuity, usually not. From a fixed, indexed or variable annuity, yes, but surrender charges may apply in the early years.
Are payout rates the same everywhere?
No. Quotes for the same person and contract can differ between insurers. Compare several before you buy.