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Annuities guide

People generally buy annuities to have a retirement income or to build savings for another purpose.

You can buy an annuity from a licensed life insurance agent, insurance company, financial planner, or broker. You should talk to a financial adviser about your needs and goals before you buy an annuity.

Types of annuities

There are two types of annuities. The difference between the two is when annuity payments begin.

  • Deferred annuities allow you to save money for retirement or other reasons. You don’t have to pay taxes on your earnings, or contributions if your annuity is an individual retirement account (IRA), until you withdraw the earnings.
  • Immediate annuities allow you to create an income stream. For example, if you get money from an inheritance or the sale of property, you can use the money to set up an immediate annuity that will pay you monthly for the rest of your life.

Deferred and immediate annuities offer several options you can choose from. The options provide different levels of potential risk and return:

  • Fixed annuities are guaranteed to earn a minimum interest rate. They are the lowest financial risk but provide lower returns.
  • Index-linked annuities earn a higher interest rate, but there isn’t a guaranteed minimum interest rate. They are low-to-moderate risk and provide moderate returns.
  • Variable annuities allow you to choose between sub accounts that are similar to mutual funds. You can earn more, but there isn’t a guaranteed return. Variable annuities are higher risk because there’s a chance you could lose some or all of your money.

Fixed annuities

Fixed annuities aren’t as risky as variable annuities because the investment risk is with the insurance company, not you. If investment performance is more than what the company needs to pay the guarantees, the difference is added to the company’s surplus. If performance is low, the insurance company bears the loss.

Fixed annuities guarantee a minimum interest rate, generally between 1% and 3%. The company might pay a higher interest rate than the guaranteed interest rate.

The insurance company determines the interest rates, which can change monthly, quarterly, semiannually, or annually. Be sure you understand how and when the interest rate changes before you buy.

Index-linked annuities

Index-linked annuities show gains or losses based on returns in indexes. Index-linked annuities are more complex than fixed deferred annuities. It’s important that you understand the features of the annuity you’re considering and what they mean.

The two contractual features that affect the amount of interest credited to an index-linked annuity the most are the indexing method and the participation rate.

  • The indexing method is how the change in the value of an index is measured. Each relies on the index term, which is when the company calculates the interest and credits it to your annuity.
  • The participation rate determines how much of the increase in the index will be used to calculate the index-linked interest.

Other important features of indexed annuities include:

  • Rate cap. Some annuities cap the index-linked interest rate. This is the maximum rate of interest the annuity will earn.
  • Floor on equity index-linked interest. The floor is the minimum index-linked interest rate you will earn. Not all annuities have a floor. All fixed annuities have a minimum guaranteed value.

    Some companies use the average of an index’s value rather than the value of the index on a specified date. The index averaging may happen any time during the term of the annuity.

  • Interest compounding. Some annuities pay simple interest during an index term. The index-linked interest is added to your original premium amount but doesn’t compound during the term. Other annuities pay compound interest during a term. This means that interest already credited also earns interest. In either case, the interest earned in one term is usually compounded in the next.
  • Margin/spread/administrative fee. In some annuities, the index-linked interest rate is determined by subtracting a percentage from any calculated change in the index. This percentage might be used instead of or in addition to a participation rate.

    If you take out all your money before the end of the term, some annuities won’t credit the index-linked interest. Some annuities might credit only part of the interest. The percentage vested generally increases as the term nears the end and is always 100% at the end of the term.

Variable annuities

Variable annuities can provide higher returns than fixed and index-linked annuities, but they also have a greater risk. This is because you bear the investment risk rather than the insurance company.

Your agent or financial adviser can help you decide whether a variable annuity is right for you.

The Securities and Exchange Commission classifies variable annuities as securities because the performance is derived from stocks, bonds, and other investments. An agent selling variable annuities must have a state license and be registered with the Financial Industry Regulatory Authority (FINRA).

Annuity phases

An annuity contract has two phases: an accumulation phase and a payout phase.

Accumulation phase

Your annuity earns interest during the accumulation phase.

You have several options on how you contribute to an annuity, depending on the annuity you buy:

  • Flexible and periodic payments allow you to choose the time and amount of the payment.
  • Single premium allows you to make one payment at the beginning of the annuity.
  • Fixed payments allow you to make the same payment at the same interval, either monthly, quarterly, or annually.

The Internal Revenue Service (IRS) regulates the taxation of annuities. The IRS allows you to defer the tax on earnings until you withdraw them. If you withdraw your earnings before age 59½, you will probably have to pay a 10% early withdrawal penalty in addition to the taxes you owe on the interest earned. There are some exceptions to this rule.

If the annuity is an IRA, your contributions and your earnings are usually tax-deferred. If the annuity is a Roth IRA, the money and earnings are usually tax-deferred and then tax-free when you withdraw them..

Visit IRS.gov or talk to your agent, financial adviser, or tax professional to understand the how the IRA you’re considering is taxed.

Payout phase

After the accumulation phase ends, an annuity enters its payout phase. This is sometimes called the annuitization phase. There are several options for getting payments from your annuity:

  • Fixed amount option. Your company pays you a fixed amount for the time stated in the contract.
  • Life-only option. The company makes payments to you for as long as you live, but there are not any payments to your heirs after you die.
  • Life option with a period certain.You get payments for as long as you live. If you die before the end of a specified period of time (usually 10, 15, or 20 years), the person you name as your beneficiary will get payments until the period ends.
  • Joint and survivor life option. The company makes payments to you or your beneficiary for as long as either is alive.

Your payment or the amount paid to your beneficiary will be different under each option. Talk to your agent or financial adviser to make sure your selection meets your needs.

Surrender charges

Many annuities charge a penalty if you withdraw money before the payout phase. This penalty, called a surrender charge, is typically highest in the early years of the annuity. The charge is often a percentage of the withdrawn money, and generally starts at about 10% and drops each year until the surrender period is over.

Annuities are tax-deferred to encourage saving for your retirement. If you withdraw money before the age of 59½, the IRS usually charges a 10% penalty.

Your contract might include a free withdrawal option. This means you can withdraw money each year without the company charging a surrender penalty. Typically, the free withdrawal amount is 10% of the accumulated value. You might owe taxes on the money you withdraw, and you might have to pay the IRS’ early withdrawal penalty.

The load or commission

Annuities have other fees called loads or commissions. Sometimes, these fees can be as much as 2% of an annuity’s value. Include these fees when estimating the cost to buy an annuity and the amount you will earn from it.

Tips for buying annuities

If an annuity is a good option for you, use these tips to help you shop:

  • Shop around. Premiums and benefits vary from company to company, so talk to more than one company and compare.
  • Before shopping, decide how much financial risk you’re willing and able to take. Remember, fixed annuities guarantee a minimum rate of return so they are less risky. Variable annuities have the potential for higher earnings, but there’s more risk that you’ll lose money. Be careful about putting all your assets into an annuity.
  • Make sure that the agent and company are licensed. Agents and companies must have a Texas insurance license to legally sell annuities in the state.
  • Check the company’s complaint index. The complaint index is an indication of a company’s customer service record. Learn about a company’s licenses status, complaint history, and financial rating from an independent rating organization by calling our Help Line or by visiting our website.
  • Don’t rush into a purchase. Take time to decide.
  • Consider bringing a trusted family member or friend with you when you meet with an agent.
  • Use your free-look period to review the annuity and make sure it meets your needs. Annuities sold in Texas must have a 20-day free-look period. Replacement annuities have a 30-day free-look period. During the free-look period, you may cancel the contract and get a full refund.
  • Understand the annuity you’re considering. A financial adviser can help you evaluate the annuity and compare it to other investments. A financial adviser or tax professional can also help you understand the tax consequences of the annuity you’re considering.
  • Ask the agent or company these questions:
    • What is the guaranteed minimum interest rate?
    • What is the current interest rate?
    • Is there a bonus interest rate? If yes, what are the requirements for you to get the bonus interest rate?
    • What are the surrender period and charges?
    • Is there a free withdrawal option? If there is, what are the terms?
    • Can the annuity lose value?
    • Will the annuity pay my beneficiaries after I die?
    • What is the maturity or annuitization date?
    • What are the fees?

Replacing an existing annuity with a new one

It’s against the law for agents to recommend that you replace your annuity with another one just so they can earn commissions. If an agent suggests that you replace an annuity or if you’re considering replacing an annuity, know these things:

  • The accumulated value in your annuity before replacement.
  • The amount of any surrender charges.
  • Whether you’ll lose any bonus interest or features if you give up your annuity.
  • The guaranteed interest rates of both your annuity and the one you’re considering replacing it with.
  • How much money you’ll need to start the new annuity.
  • The loads or commissions for the new annuity.
  • Whether the new annuity will meet your needs better than your current one.

Regulating annuities

The Texas Department of Insurance (TDI) licenses and regulates agents and companies that sell annuities in Texas. Since variable annuities are investments, TDI and the U.S. Securities and Exchange Commission jointly regulate the companies that sell annuities. Agents who sell variable annuities must be registered with FINRA and have a TDI license.

TDI also works with the Texas State Securities Board on issues involving agents that sell variable annuities.

Make sure any agent or company you’re considering buying from is licensed and financially stable. To verify the Texas license status of an agent or company, call our Help Line at 800-252-3439. You can also use the Company Lookup feature to learn a company’s financial rating from an independent rating organization.

For variable annuities, you can confirm an agent’s registration with FINRA at brokercheck.finra.org.



Question? Call us at 800-252-3439.

Last updated: 5/2/2022