At its core, annuities solve one of the hardest retirement questions: How do I turn my savings into income I can rely on — without worrying about market crashes or running out of money?
Instead of managing withdrawals on your own, you transfer some responsibility to an insurance company. In return, the insurer agrees in writing to pay you based on the rules you choose. Those rules cover when payments start, how long they last and whether anyone else is protected after you’re gone. Many people think of annuities as a way to create a personal pension — income you can count on, regardless of what the market does.
How Does an Annuity Work: Step by Step
While annuities can look complex at first, the basic process is straightforward.
- 1. You Pay a Premium
- You fund an annuity with a premium — usually a lump sum from savings, a 401(k) rollover or an IRA. Some annuities also allow multiple contributions over time.
- 2. The Annuity Enters a Growth or Income Phase
- Growth phase: Your money grows tax-deferred before income begins.
Income phase: Payments start, often monthly, based on your contract terms. - 3. The Insurance Company Manages the Funds
- Insurance companies invest annuity premiums conservatively, typically in bonds and other low-risk assets. This structure supports predictable payments rather than market speculation.
- 4. You Receive Payments Based on Your Choices
- You decide how payments are made — monthly, quarterly or annually — and whether they last for a set period or for life.
- 5. Taxes Apply When Income Is Paid
- Taxes depend on how the annuity was funded and how money is withdrawn. In many cases, only the earnings portion of each payment is taxable.
Immediate vs. Deferred Annuities
One of the biggest distinctions between annuities is when income begins. Some people need income right away to cover everyday expenses, while others are planning ahead and want income later in retirement. Knowing where you fall on that timeline makes it much easier to understand how annuities work, and which type may make sense for you.
Immediate Annuities
Immediate annuities are designed for people who want income to start soon, usually within 12 months of purchase.
Who they’re often used by:
• People already retired
• Those who want a dependable monthly check to cover essential expenses
Deferred Annuities
Deferred annuities allow your money to grow first. Income begins late, often years down the road, when you decide you need it.
Who they’re often used by:
• People still working
• Those planning to supplement Social Security later
Fixed vs. Indexed vs. Variable Annuities
Not all annuities work the same way, and much of the confusion comes from grouping very different products together. The key difference between fixed, fixed index and variable annuities is how returns are generated and how much market risk you take on. Some annuities are designed to provide stability and predictable income, while others offer growth potential in exchange for more exposure to market ups and downs. Understanding these differences can help you choose an annuity that fits your timeline, income needs and comfort with risk — and avoid surprises later.
Fixed Annuities
Fixed annuities offer predictable growth and income with no exposure to stock market losses.
Often used by:
• People who want stability
• Those avoiding market risk
• Retirees seeking dependable income
Fixed Index Annuities
Fixed index annuities link returns to a market index while protecting against market losses.
Often used by:
• People seeking growth with protection
• Those open to capped upside
• Pre-retirees and retirees
Variable Annuities
Variable annuities are linked to the market, so value and income can rise or fall over time.
Often used by:
• People comfortable with market risk
• Those prioritizing growth
• Experienced investors
When a person is contemplating purchasing an annuity, they need to ask themselves what they are trying to accomplish. If the answer is that they want a fixed rate of returns, guaranteed lifetime income or the peace of mind of having some of their money in a “safe money” account, then an annuity could be the right choice.
John Stevenson, CFFOwner and Advisor at Stevenson Retirement SolutionsJohn Stevenson, a Certified Financial Fiduciary®️, specializes in securing retirements with tax-free accounts. With a focus on guaranteed retirement, he’s ensured none of his clients suffer from market fluctuations. As a renowned educator and podcast host, John empowers thousands weekly, sharing his expertise in minimizing taxes and protecting against financial downturns.
What Happens to Your Money if You Die?
This is one of the most common and important questions people ask when learning about annuities. Many worry that if they pass away early, their money will simply disappear. In reality, what happens depends on how the annuity is structured and which options you choose upfront.
Depending on the features built into your contract, an annuity can:
- Pay income for your lifetime, even if you live longer than expected
- Continue payments to a spouse through a joint-life option
- Guarantee payments for a minimum number of years, regardless of when you pass away
- Return remaining value to beneficiaries through refund or death benefit provisions
For example, a lifetime-only annuity typically stops payments at death, which allows for higher monthly income while you’re alive. Other options, such as period-certain, joint-life or refund features, ensure payments continue to a spouse or beneficiaries if you pass away sooner than expected.
It’s important to understand that adding guarantees usually reduces monthly payments, because the insurance company is taking on additional risk. Many people find this trade-off worthwhile for the peace of mind that comes with knowing loved ones are financially protected.
Are Annuities Safe?
Annuities are issued by insurance companies and backed by their financial strength. Providers are evaluated by independent rating agencies such as AM Best, and additional protections may be available through state guaranty associations.
While no financial product is completely risk-free, annuities are designed to reduce market risk and provide contractual guarantees.
Is an Annuity Right for You?
Annuities aren’t for everyone, and that’s okay. They’re designed to solve specific retirement challenges, mainly turning savings into dependable income and reducing uncertainty. An annuity may make sense if you:
- Want predictable income you can plan around, rather than guessing how much you can safely withdraw each year
- Are concerned about market volatility, especially if a downturn could disrupt your retirement plans
- Don’t want to manage withdrawals on your own or worry about making a mistake that could shorten how long your money lasts
- Want more confidence that your income will last, even if you live longer than expected
Annuities are often used alongside other retirement accounts, not instead of them. If you’re unsure whether an annuity fits your situation, comparing different types and seeing personalized estimates can help you understand what trade-offs — and benefits — may apply to you.
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Frequently Asked Questions About How Annuities Work
Some annuities are protected from market losses, while others are market-linked. It depends on the type of annuity you choose.
They can be. Lifetime income options guarantee payments for as long as you live, based on contract terms.
Most annuities include a free-look period that allows you to cancel within a set time after purchase.
Annuities grow tax-deferred, and taxes are generally owed when income is received. The amount taxed depends on how the annuity was funded.
