What Is an Annuity? How It Works, Types, Pros & Cons (2025 Guide)

For $310 billion spent on annuities in 2022, buyers prioritized guaranteed income over access to their principal. This guide breaks down the basics, the trade-offs, and the real numbers so you can decide if an annuity fits your retirement plan.

Annuities sold in the U.S. in 2022 (premiums): $310 billion (LIMRA) ·
Average annual payout rate for a 65-year-old (single life, no inflation protection): 5.5% (Guardian Life) ·
Percentage of retirees who rely on guaranteed income: 67% (Schroders 2023 U.S. Retirement Survey) ·
Median annuity account value among U.S. households: $113,000 (EBRI)

Five key facts that shape the annuity landscape:

What is an annuity in simple terms?

Definition from a reputable source

• An annuity is a contract between you and an insurance company. You pay a lump sum or series of payments, and in return the insurer agrees to make regular payments to you for a set period or for life. Financial Consumer Agency of Canada (government regulator)
• The Guardian Life Insurance Company (a major U.S. insurer) defines an annuity as a contract that guarantees a steady income stream, often used for retirement.

Key parties: you and the insurance company

• You (the annuitant): The person who receives the payments. Financial Consumer Agency of Canada
• Insurance company: The issuer that promises to pay. California Department of Insurance (state regulator)
• Annuities are sold by licensed life insurance companies. Many well-known insurers, such as those that offer health plans like Blue Cross Blue Shield of Texas, also sell annuity products through their life insurance divisions.

Annuity vs pension comparison

Both annuities and pensions provide guaranteed income for life, but there are key differences. A pension is typically employer-sponsored and managed by the employer, while an annuity is an individual purchase. The U.S. Social Security system functions like a government-run annuity — it provides a guaranteed monthly check based on your earnings history. The New Deal program established Social Security, which is essentially a government annuity. Private annuities offer more flexibility but also come with fees and risks.

How an annuity works step by step

1. You decide how much to invest (lump sum or periodic payments).
2. You choose an annuity type: immediate or deferred, fixed or variable.
3. You select payout options: single life, joint life, period certain, etc.
4. You sign the contract and the insurer invests your premium.
5. Payments begin according to the schedule (immediately or later).
6. You receive a guaranteed income stream for life or a specified term. Financial Consumer Agency of Canada

What is an annuity example?

Example: immediate single-life annuity for a 65-year-old

• Suppose you invest $100,000 today in an immediate fixed annuity. At age 65, you can expect monthly payments of roughly $550 to $600 for the rest of your life. Financial Consumer Agency of Canada (government regulator) explains that payout amounts depend on age, interest rates, and contract terms.
• A joint-life option (covering a spouse) would reduce the monthly payment to around $450–$500. Global Investments (UK pension guide)

Example: fixed deferred annuity

• You invest $100,000 at age 55 with a guaranteed interest rate of 3% for 10 years. At age 65, you can annuitize the accumulated value (about $134,000) into a monthly income. California Department of Insurance (state regulator)

How to calculate monthly payments

You can use online calculators, but the key inputs are your age, gender, health, amount invested, annuity type, and payout option. The Financial Consumer Agency of Canada provides a list of factors that influence your income. Higher interest rates and older age at purchase generally lead to higher monthly payments.

The pattern: The earlier you buy and the longer you wait to start payments, the larger your monthly check can be. But that growth comes at the cost of having your money locked up for years.

What is the downside of an annuity?

High fees and surrender charges

• Surrender charges can be 7% or more if you withdraw during the early years of the contract. National Association of Insurance Commissioners (NAIC, U.S. insurance regulator) model regulations.
• Annual expense ratios for fixed annuities are typically 1–2%, and variable annuities can run 2–3% per year. Investopedia (financial information website)
• Withdrawals before age 59½ may incur a 10% federal tax penalty. Colorado Bar Association (legal professionals)

Loss of liquidity

• Once you annuitize, you generally cannot access the lump sum for emergencies. Annuity.org (consumer education site)
• Many contracts limit annual withdrawals to 10% of the account value; exceeding that triggers fees. Annuity.org

Complexity and confusing terms

• Annuity contracts are dense with jargon: riders, M&E fees, spread, cap rates, participation rates. California Department of Insurance (state regulator)
• The first rate shown in the UK annuity purchasing process is often the single, level option, which may not be the best fit. Financial Conduct Authority (UK financial regulator)

Counterparty risk

• If the insurance company fails, you could lose your income. State guaranty associations provide limited coverage (typically $250,000 per policy). NOLHGA (National Organization of Life and Health Insurance Guaranty Associations)

The implication: The fees and lack of liquidity can turn a retirement safety net into an expensive trap. Anyone considering an annuity should factor in the total cost of ownership, not just the headline payout rate.

Why do people say to avoid annuities?

Sales practices and high commissions

• Commissions on annuity sales can be 5–10% of the principal, which are built into the product’s cost. Investopedia (financial information website)
• These commissions create a conflict of interest: agents may recommend an annuity because it pays them well, not because it’s the best fit for your situation.

Inflation risk with fixed payouts

• Fixed annuities do not adjust for inflation unless you buy a cost-of-living rider, which reduces the initial payout by 20–30%. Global Investments (UK pension guide)
• Even a 2% annual inflation rate can cut the real value of a fixed payment by nearly half over 30 years.

Opportunity cost vs. other investments

• Your money is tied up for years, missing out on potentially higher returns from stocks or real estate. Investopedia notes that the long-term trade-off between guaranteed income and investment growth is a key consideration.
• If you are in good health, you may be better off with a systematic withdrawal strategy from a diversified portfolio.

The trade-off: Annuities offer peace of mind at the cost of growth potential. For someone who values guaranteed income above all, the trade-off may be worth it. But for most, the loss of liquidity and opportunity cost outweigh the benefits.

How much does a $100,000 annuity pay per month?

Factors affecting monthly payout

• Your age and gender (women live longer, so payouts are slightly lower).
• Current interest rates (higher rates = higher payouts).
• Whether you choose single life, joint life, or period certain.
• Inflation protection riders reduce initial payouts.
• Your health status (smokers or those with health issues may qualify for enhanced rates, but this is rare in the U.S.). Financial Consumer Agency of Canada (government regulator)

Three common scenarios, one pattern: the older you are when you start, the more you get per month.

Single life vs. joint life vs. period certain

• Single life: Highest monthly payment, but payments stop at your death. No value left for heirs.
• Joint life: Lower monthly payment, but payments continue for your spouse’s lifetime.
• Period certain: Payments guaranteed for a set number of years (e.g., 10 or 20 years), even if you die early. The remaining payments go to your beneficiary.

All options are trade-offs: higher security for you or your spouse means a lower starting payment. Global Investments

The implication: Your monthly income is a direct function of the risks you are willing to take — the more guarantees you want, the less you get each month. For a single retiree with no dependents, a single-life annuity maximizes income. For a couple, the joint-life option provides peace of mind but at a cost.

Key differences between annuity types

Four common annuity types, one pattern: the more control you give up, the more income you can receive.

Source: California Department of Insurance and Financial Consumer Agency of Canada

Pros and cons of annuities

How to buy an annuity: step by step

1. Assess your retirement income needs. Determine how much guaranteed income you need beyond Social Security and any pensions.
2. Compare quotes from multiple insurers. Use an independent broker or online comparison tool. Financial Consumer Agency of Canada recommends shopping around.
3. Choose the annuity type and payout option. Decide between immediate or deferred, fixed or variable, and whether you want a single life, joint life, or period certain payout.
4. Apply and go through underwriting. The insurer will review your age, health, and other factors. In some cases, you may need a medical exam.
5. Fund the contract. Pay the lump sum or set up periodic payments.
6. Review the free-look period. Most states require a 10- to 30-day period during which you can cancel without penalty. Annuity.org
7. Start receiving payments. For immediate annuities, payments begin within one year. For deferred, they begin at the date you selected.

What we know for sure and what’s still unclear

Confirmed facts

• Annuities provide guaranteed income for life or a specified term. Financial Consumer Agency of Canada
• Payout rates are lower for joint life vs. single life. Global Investments
• Fixed annuities have guaranteed interest rates set by the insurer. California Department of Insurance
• Surrender charges apply during the surrender period. NAIC

What’s unclear

• Exact monthly payout amounts depend on the individual’s age, gender, health, and the specific insurer’s rates, which change frequently. Financial Consumer Agency of Canada
• Whether annuities are a “good” investment depends on personal financial goals and alternatives (e.g., systematic withdrawals vs. guaranteed income).
• The actual impact of fees on long-term returns varies by annuity product. Investopedia

An annuity is a contract that guarantees a steady income stream for life, helping you manage your retirement savings.

Guardian Life Insurance Company (a major U.S. insurer)

When you buy an annuity, you’re essentially exchanging your pension pot for a guaranteed income for the rest of your life.

Standard Life (a UK pension and retirement provider)

Annuities can be a way to turn your savings into an annual pension that you cannot outlive.

Age UK (a UK charity for older people)

The decision: Annuities are not a simple product. They trade a lump sum for a lifetime of guaranteed payments — but that guarantee comes with steep fees, limited access to your money, and inflation risk. For a retiree evaluating annuities, the choice hinges on whether predictable cash flow matters more than maintaining control of your principal. If it does, an annuity can be a valuable tool — but only after you’ve compared multiple offers and understood the fees.

Related reading: Blue Cross Blue Shield of Texas: Login, Plans, Cost · What Was the New Deal? Goals, Programs, Impact and Legacy

To see how different lump sums translate into monthly income, you can use an annuity payout calculator to estimate your potential payments.

Frequently asked questions