Jeanette Beebe is an experienced journalist, fact-checker, and audio producer covering personal finance, retirement, science, business, medicine, technology, and the arts. Her reporting has appeared in Investopedia, Time Health, Scientific American, Popular Science, AARP, Fast Company, and elsewhere.
Updated July 15, 2024 Reviewed by Reviewed by Marguerita ChengMarguerita is a Certified Financial Planner (CFP), Chartered Retirement Planning Counselor (CRPC), Retirement Income Certified Professional (RICP), and a Chartered Socially Responsible Investing Counselor (CSRIC). She has been working in the financial planning industry for over 20 years and spends her days helping her clients gain clarity, confidence, and control over their financial lives.
An annuity contract is a written agreement between an insurance company and a customer outlining each party's obligations in an annuity agreement. Such a document will include the specific details of the contract, such as the structure of the annuity (e.g. variable or fixed); any penalties for early withdrawal; spousal and beneficiary provisions (such as a survivor clause and rate of spousal coverage); and more.
An annuity contract is a contractual obligation between as many as four parties. They are the issuer (usually an insurance company), the owner of the annuity, the annuitant, and the beneficiary. The owner is the person who buys an annuity. An annuitant is an individual whose life expectancy is used to determine the amount of the payout and when benefits payments will start and cease. (In most cases, though not all, the owner and annuitant are the same person.) The beneficiary is the individual designated by the annuity owner who will receive a death benefit when the annuitant dies.
The annuity owner and the annuitant are often the same person, but not always.
When shopping for an annuity, keep an eye on multiple-tier contracts for withdrawing money. Tier 1 allows for withdrawals over a lifetime (or annuitization value—basically, an immediate annuity payout). Tier 2 may be enacted if the annuity owner wants to take out their entire balance as a lump-sum payment, in which case the annuity seller may reduce the value of benefits by 10% or even 20%. The key is knowing if an annuity contract includes multiple tiers and what penalties may be triggered if the owner wants to liquidate their annuity.
Also keep in mind that insurance companies offer high teaser rates to entice buyers—to get them in the door—but these rates don't last long. They can be quickly followed by far lower rates for the life of the annuity contract. The way around this issue is to require the annuity seller to fully disclose the rate you will pay for the life of the annuity.
Annuity contracts have different withdrawal amount policies—make sure they are flexible. For example, many have a 10% withdrawal amount, but if you want to defer and instead withdraw 20% after two years, make sure that is an option without a penalty (i.e., for a cumulative withdrawal).
When you (as an individual or an organization) are designated as the beneficiary of an inherited annuity, you gain possession of the annuity, typically after the owner has died. (Note: This is based on the owner's death, not the annuitant's. The owner and annuitant are usually the same person, but not always.)
You will have essentially three options: withdraw funds in a lump sum, receive periodic payments for the rest of your life, or follow what is called the five-year rule, which states that you must withdraw the entire balance over five years. Note: These rules—and the taxes involved—can be complex, so consider consulting a financial professional.
An annuity contract can last for many years or less than one, depending on how long the owner lives and whether they named a beneficiary. A period-certain annuity lasts for the number of years that is specified in the contract. An annuity with a death benefit might extend for as long as the beneficiary is alive—so the annuity owner's lifetime, plus the beneficiary's lifetime.
In general, the payout depends on the length of the annuity. A period-certain annuity, which is limited in duration, will typically have a higher payout per month, quarter, or year than a life annuity, or an annuity with a rider that outlined a death benefit for a beneficiary or beneficiaries.
A surrender period is the period during which an annuity owner will be penalized for withdrawing their money from an annuity. A surrender period typically lasts years, sometimes a decade or even more.
If you withdraw funds from your annuity during the surrender period, you'll be hit with a surrender fee, which can be in the double digits. The fee typically decreases every year that passes as the surrender period continues, until the surrender period ends and the fee is at zero. For example, the surrender fee might be 15% for the first year of the annuity contract, and then go down by 1% per year, until the end of the 15th and final year of the surrender period. So at the end of 15 years, you'll be able to withdraw funds fee-free—as long as it's under certain limits (such as 10% of the total annuity).
Rules vary, so make sure to read the fine print.
An indexed annuity, or an equity-indexed annuity, is a type of fixed annuity. This complex, moderately risky insurance product tracks the performance of a particular index, such as the S&P 500. However, it does not participate in the market, like a variable annuity.
As an investor planning for retirement, you might think an annuity contract would be a good idea, because it legally requires an insurance company to provide a guaranteed periodic payment to the annuitant once the annuitant reaches retirement. Essentially, it guarantees retirement income.
However, annuity contracts may not be worth it for many investors. Annuities can be complex, and the associated fees can be high. The amount of return may not keep pace with inflation. Do your due diligence and weigh the pros and cons carefully before signing up—if you decide to sign up at all.