Annuities explained: Finding the right type for your retirement goals
Investment options for retirees are different from investments for younger Americans. Retirees no longer get regular paychecks, so they must rely on other sources of income, such as Social Security payments, pensions, and proceeds generated from stocks, bonds, certificates of deposit, and other traditional investments.
Retirees also often consider investing in fixed, variable, and indexed annuities because they can provide capital growth and a stable source of income. This guide explains how fixed annuities, variable annuities, and indexed annuities work, along with their returns, risks, and how to choose the best annuity rates.
What are annuities, and why consider them?
Annuities are contracts purchased from insurance companies. Depending on your liquidity, financial resources, and retirement income needs, you’ll either pay a monthly premium or a large lump sum up front, and you’ll receive income based on fixed, variable, or indexed returns. Payments can continue for a set period or for life, depending on the contract. Income may be paid immediately or deferred to a future date. Annuity benefits can help fill financial gaps and help you maintain your desired standard of living.
Annuities have three primary benefits:
- Set distributions. Once you start taking periodic payments, they may continue for a set period or for life, depending on the contract.
- Tax-deferred growth. Your initial investment grows on a tax-deferred basis. You won’t have to pay any taxes on those gains until you begin taking disbursements.
- Survivor benefits. Your named beneficiary receives your annuity benefits if you pass before you begin withdrawing funds.
Annuity sales totaled $347 billion in the third quarter of 2025, according to LIMRA (Life Insurance Marketing and Research Association), with a prediction of continued increase.
All three types of annuities are regulated by state insurance commissioners. However, since variable annuities and indexed annuities are sold as securities, they are also regulated by the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority.
Let’s take a closer look at the three main types of annuities and how they work.
Best fixed annuities: Guaranteed returns with predictable income
Fixed annuities are the simplest type of annuity, and they work much like a certificate of deposit (CD).
How fixed annuities work
With fixed annuities, retirees build up an account balance either by making regular contributions or by investing a large sum of money. You’ll know your interest rate going into the contract, so you can calculate how much and how quickly your funds will grow on a tax-deferred basis (the accumulation phase) until you start taking regular payments (the distribution phase).
Income disbursements can last between 10 and 20 years or for the duration of your life, depending upon your contract. If you die before reaching the term of your contract — and it includes a death benefit rider — monthly distributions continue and will go to your designated beneficiary.
Fixed annuity returns and risk profile
Fixed annuities have the least risk since investors enjoy guaranteed, stable, and fixed returns each month regardless of any volatility in public equity markets or the national financial landscape. There is generally no risk to the principal when held to contract terms.
Fixed annuities do carry inflation risk. Your returns may not keep pace with rising inflation, which could impact returns over time.
Best for: Fixed-rate annuities are often considered among the best fixed annuities for conservative investors seeking predictable income.
Best variable annuities: Market growth potential with higher risk
Variable annuities are much different than fixed annuities. You may realize much higher growth with variable annuities, but you’ll also potentially put your investment capital at higher risk. Here’s how they work.
Understanding variable annuity structure
Variable annuity contracts allow you to choose from a range of investment options. Your account value may increase significantly if you choose the right investments and they realize significant growth, but you also run the risk of losing a portion of your original investment capital if your underlying investments underperform.
Investment options are usually mutual funds that consist of a mix of stocks, bonds, and short- or long-term money market instruments such as Treasury Bills, certificates of deposit (CDs), and commercial paper.
Income generated from your investments is tax-deferred, so you won’t have to worry about any tax liability until you start taking distributions. The amount of your distribution payments, meanwhile, will depend on how well your investments performed in their underlying sub-accounts.
Variable annuity risk and return analysis
Returns on variable annuities can vary greatly, which is why they carry a much higher degree of risk than fixed annuities.
Some variable annuities offer optional risk-control features or riders designed to help manage volatility, but these typically come with additional costs and don’t eliminate market risk.
Variable annuity fees
Variable annuities have many fees that are unique to annuities. Your contract may include charges that will be deducted from your sub-accounts to cover the following:
- Administrative and distribution costs
- Mortality and expense risk charges (M&E)
- Annual contract maintenance
- Sub-account fees and expenses
- Sales or surrender charges for early termination
- Investment advisory fees
Some of these fees depend on how your annuity is held — it will cost less to have your annuity held in a brokerage account than in a managed advisory account.
Best for: Variable annuities are best for investors seeking capital growth and who are comfortable assuming additional market risk. If you feel confident that you won’t terminate the contract early and are OK with a “set-it-and-forget-it” investment approach, it makes sense to hold the annuity in a brokerage account rather than in a managed account to reduce the impact of added fees that are common to variable annuities.
Best indexed annuities: Balanced approach to growth and protection
Indexed annuities share characteristics of both variable and fixed annuities. They are complex investment options that have the potential to deliver solid returns. They offer growth potential with downside protection, though returns are limited by caps and participation rates.
How indexed annuities balance risk and reward
Indexed annuities are often correlated to broader market indexes, though the S&P 500 is the most common benchmark used.
Indexed annuities provide room for capital growth, though returns may not be as much as you could potentially receive through variable annuities, but could be greater than fixed annuities. Similarly, your downside risk is less than with variable annuities but slightly higher than with fixed annuities.
There are two main types of indexed annuities:
- Equity-indexed annuities
- Registered index-linked annuities
Both offer returns based on one or more market indexes, but equity-indexed annuities come with a guaranteed minimum return rate.
Indexed annuity return mechanics
Indexed annuities provide interest on your investment capital that is tied to the performance of a market index, such as the S&P 500. They typically have a participation rate that determines how much interest you can earn from gains in the index, commonly between 80% to 90%. Some caps limit how much interest can be credited to your account, usually between 2% and 15%.
Participation rates and caps limit growth. Many indexed annuities include a floor of 0%, meaning you won’t earn interest in a down market, but typically won’t lose principal due to market performance.
Best for: Indexed annuities are often used by investors seeking a balance between growth and protection. Since indexed annuities have so many different options, rates, caps, and floors, it would be wise to discuss contract details with a financial professional prior to investing.
How to choose the best annuities for your situation
Deciding which type of annuity is best for your situation involves many different factors, including your appetite for risk, desire for capital growth, investment horizon, and other important financial metrics.
Key factors to consider when choosing the best annuities for your needs:
- Your risk tolerance
- When you will need the income
- Whether your income needs are immediate or long-term
- Fees and costs
- Your liquidity needs
- Insurance company financial strength
Your age plays a significant role in choosing an annuity. Older investors will enjoy higher payouts because they have a shorter life expectancy. Younger investors, meanwhile, have more time to realize capital growth from their annuities, though other investment options may provide higher returns. Annuities are often best for mid-life financial planning since they give you room for growth and offer guaranteed income during your retirement years.
Risk is another consideration. Retirees are typically focused on capital preservation rather than growth, so fixed annuities may be their best option. Variable annuities offer the potential for greater returns but can expose your investment to market losses. Indexed annuities provide more limited growth with downside protection, though returns are capped.
Fees are another important consideration. Variable annuities have more fees than other types of annuities, and those fees could impact your potential yield. You’ll also want to take into account any potential surrender fees if you happen to break the contract due to immediate liquidity needs.
Finally, consider which type of annuities offer options to have payments continue to a designated beneficiary upon your death. You may have to pay for a death benefits rider, but it could be an important tool in estate planning for your spouse or other beneficiary.
Putting your annuity strategy into action
If you’re considering annuities as part of your retirement plan, keep in mind the following:
Fixed annuities are the most conservative option. They offer a steady interest rate and a payout that is consistent over time. Variable annuities offer the greatest potential for capital growth, but they also pose the highest level of risk if your investments flounder. Indexed annuities walk the middle ground between the two, but they are complex financial instruments that may require the insight of a registered financial professional to help ensure they meet your financial goals.
Before purchasing any type of annuity, it’s important to assess your financial situation and retirement goals. Consult a registered financial professional about your options, and compare contracts offered by multiple insurers to determine which ones best match your investment strategy.
Once you’ve done all the legwork, you can compare options and request quotes from multiple providers.
