Common Annuity Myths

This is one of the most consequential misconceptions in annuity planning, because the major annuity types differ from each other more than most financial products differ from their alternatives. Fixed annuities (MYGAs) provide a guaranteed interest rate for a specific term with no market risk — the interest amount is known in advance and the account value never declines due to index or market performance. Fixed indexed annuities (FIAs) protect principal from market losses and credit interest based on an index formula using caps, participation rates, or spreads — meaning credits are variable from year to year and depend on index performance within the contract’s parameters. Immediate income annuities (SPIAs) convert a premium directly into a guaranteed payment stream starting right away, with no accumulation phase. Deferred income annuities (DIAs) are purchased today for income that begins at a future specified date. Variable annuities invest in market-based subaccounts and carry genuine market risk — the account value can decline. Registered index-linked annuities (RILAs) provide defined buffer or floor protection against market losses while allowing participation in index gains.

The differences between these product types are not cosmetic — they affect risk exposure, growth potential, liquidity, income options, fees, and the planning scenarios where each is appropriate. An FIA and a variable annuity are as different from each other as a savings account and a stock portfolio, even though both carry the word “annuity.” Our Annuities 101 guide provides the foundational comparison across major annuity types.

Pre-retirees commonly use fixed annuities and MYGAs as principal-protected accumulation tools — particularly after maxing out 401(k) and IRA contributions and wanting additional tax-deferred growth without market exposure. A conservative saver in their late 40s or 50s can use a 5- or 7-year MYGA to grow retirement assets at a guaranteed rate while keeping a defined portion of the portfolio completely protected from market volatility during the critical pre-retirement accumulation years. Fixed indexed annuities with future income riders are also frequently used by pre-retirees who want to accumulate toward a guaranteed income stream that will begin at a future date.

Income annuities — including SPIAs and DIAs — are most commonly purchased at or near retirement, because the planning objective shifts from accumulation to income distribution. A deferred income annuity purchased at 55 for income beginning at 70 is used by a pre-retiree to lock in future income protection at a time when they are still working, at rates more favorable than waiting until 70 to purchase. Multi-year guaranteed annuities used to ladder retirement asset maturities across different years — creating scheduled liquidity opportunities — are also commonly employed by pre-retirees managing the transition from accumulation to distribution. Annuities serve different purposes at different life stages; the planning conversation changes, but the relevance of the product category does not end at retirement.

For fixed annuities and fixed indexed annuities, principal protection from market losses is a defining contractual feature. The account value in a fixed annuity or FIA does not decline because of market index performance — if the S&P 500 drops 30% in a given year, a fixed annuity continues crediting its guaranteed rate unaffected, and an FIA credits zero for that year rather than a negative return. The account value that accumulated before the decline is preserved; no loss is applied. This is the core distinction that separates principal-protected insurance products from market-invested accounts, and it is one of the most important features for retirees or near-retirees who cannot absorb significant portfolio drawdowns.

Variable annuities are an important exception: they invest premiums in market-based subaccounts that are subject to market losses, and the account value can decline. Variable annuities carry genuine market risk that is explicitly disclosed in their prospectuses. The “principal protection” characteristic applies to fixed and indexed products, not to variable annuities. This distinction is critically important when evaluating annuities, because conflating variable and fixed annuity features in either direction produces incorrect planning decisions. Our resource on what happens to an indexed annuity if the market goes down explains how FIA downside protection works in specific market scenarios.

Most fixed annuity and FIA contracts include annual free withdrawal provisions — commonly allowing access to 5% to 10% of the account value per year without triggering surrender charges. This means a meaningful portion of the contract is accessible each year during the surrender period, not locked away entirely. For owners whose expected annual withdrawal needs fall within the free withdrawal allowance, the contract provides practical liquidity throughout the surrender period without penalty. Some contracts also waive surrender charges entirely in specific hardship circumstances — nursing home admission, terminal illness diagnosis, or disability — providing additional emergency access if needed.

Full access to the entire contract value without penalty occurs at the end of the surrender period, which typically ranges from 3 to 10 years depending on the product. Matching the surrender period to the intended holding period for the specific dollars being allocated — not using money intended for short-term needs in long-term fixed annuity contracts — is the key discipline that prevents liquidity frustration. An annuity is not the right tool for money that may need to be accessed unpredictably or in full on short notice. It is well-suited for money that can be committed for a known term, with planned partial access through annual free withdrawal provisions. Our resource on annuity free withdrawal rules explains how these provisions work across common contract designs.

Fixed annuities (MYGAs) and many base fixed indexed annuity contracts carry no annual policy fee — the credited rate is a net rate after the insurer’s internal costs, and no separate charge is deducted from the account value each year. What you see as the credited rate is what accrues to the account. Optional income riders added to FIAs — guaranteed lifetime withdrawal benefit (GLWB) riders — do carry annual fees, typically between 0.50% and 1.50% or more of the benefit base per year, which reduce net accumulation compared to the same contract without the rider. Whether a rider’s fee is justified depends on whether the guaranteed income the rider provides has more value than the accumulation it consumes.

Variable annuities, by contrast, typically include mortality and expense (M&E) charges, fund expense ratios on the underlying subaccounts, and optional rider fees that stack on top — making the total annual cost of a variable annuity meaningfully higher than a comparable fixed or indexed product. The myth that “all annuities have high fees” is most accurately rooted in valid concerns about variable annuity fee structures, generalized incorrectly to all annuity types. The practical guidance is to review the specific contract’s fee disclosure before purchase and understand whether any fees apply to the base contract or only to optional riders. Our resource on whether annuities have fees addresses this distinction across product types.

Annuity bonus features — upfront premium bonuses, benefit-base bonuses, or first-year enhanced crediting — are real features with real planning value in specific contexts, but they are rarely if ever “free.” Carriers that offer large bonuses typically recover the cost through other contract parameters: longer surrender periods, lower FIA caps or participation rates that limit index credits, higher income rider fees, or more restrictive free withdrawal provisions compared to bonus-free alternatives. A bonus that increases the income benefit base (a ledger value used for income calculation) rather than the actual account value does not add liquid accessible dollars — it increases the calculation input for future income amounts, which may or may not produce better total outcomes depending on the specific income payout rate and how long income is taken.

The correct evaluation of an annuity with a bonus is to model the total projected account value or total projected income against comparable annuities without the bonus over the likely holding period, accounting for the trade-offs in caps, participation, or fees. In some scenarios — particularly where the bonus is applied to the account value and the income rider fee is reasonable — the bonus can produce genuinely better outcomes than alternatives. In others, the bonus’s appeal dissolves when the full contract parameters are compared on equal footing. Our resource on bonus annuity comparison provides a framework for evaluating bonus contracts against non-bonus alternatives on a consistent basis.

Fixed indexed annuities do not invest your premium in the stock market. The carrier places premium in its general account — typically in bonds and other fixed-income instruments — and uses the interest earned on those investments to purchase index options that provide the performance linkage to the index. Your account value is in the carrier’s general account, protected from market losses, while the index-linked crediting formula uses the index only as a reference point for calculating interest credits. A positive S&P 500 return of 18% does not mean you receive an 18% credit — the contract’s cap rate (say, 8%), participation rate (say, 60%), or spread (say, 2%) limits and shapes how much of the index’s positive performance is credited to the account.

This structure is what makes downside protection possible: since your money is not actually invested in the index, it cannot be lost due to index declines. Zero is credited in negative index years, not a negative return — the account value stays flat rather than declining. Understanding this mechanism is important for setting realistic expectations about FIA performance. In favorable index years, the FIA will credit less than the index’s full return due to caps and participation limits. In unfavorable index years, the FIA credits zero while the index may be down significantly. The FIA’s long-term performance expectation reflects this asymmetry — limited upside, protected downside — which is specifically appropriate for conservative investors who want growth potential without the risk of loss. Our resource on what a fixed indexed annuity is explains the crediting mechanism in full detail.

Annuitization — the irrevocable conversion of contract value into a stream of payments — is one income access method but is not required for most modern annuity contracts. Many FIAs and some fixed annuities include optional guaranteed lifetime withdrawal benefit (GLWB) income riders that allow guaranteed lifetime income to be taken as systematic withdrawals from the contract without annuitizing. Under a GLWB, the owner retains ownership of the contract, the account value continues to accrue credits (subject to withdrawals), and remaining account value passes to beneficiaries at death — none of which occurs with traditional annuitization. The income guarantee comes from the rider’s benefit base and payout rate calculation, not from permanently converting the account into an income stream.

Immediate income annuities (SPIAs) and deferred income annuities (DIAs) do require annuitization — they are specifically designed to convert premium into guaranteed payments, and the income guarantee derives from that conversion. For owners who want guaranteed lifetime income but want to preserve access to remaining account value and maintain beneficiary rights, GLWB riders provide income without annuitization. For owners whose primary goal is maximizing guaranteed income per dollar of premium with no remaining account value concern, annuitization through a SPIA or DIA is often the more income-efficient approach. Understanding which income approach serves which planning goal prevents the conflation of these meaningfully different income mechanisms. Our resource on whether to annuitize or use an income rider addresses this comparison directly.

Whether annuity income stops at death depends entirely on the payout option selected and the type of annuity involved. Life-only payout options — which produce the maximum monthly income — do stop at the annuitant’s death with no further payments to heirs. But period-certain options guarantee payments for a minimum time period, continuing to beneficiaries if the annuitant dies within that period. Cash refund and installment refund options guarantee that total payments received by the annuitant and beneficiaries will at least equal the original premium — passing the unpaid balance to beneficiaries at death. Joint life options continue payments to a surviving spouse at a specified percentage for as long as either spouse is alive.

For accumulation annuities (fixed, indexed, or variable) that have not yet begun income, the death benefit at death during the accumulation phase is typically the contract’s account value, passed directly to named beneficiaries — often avoiding probate. Enhanced death benefit riders on some contracts guarantee a minimum death benefit above the account value. The idea that “the insurance company keeps your money” when you die reflects how life-only payout annuitization works — which is one specific option chosen for one specific reason (maximum income) — not how most modern annuities are designed to work. Our resource on what happens to your annuity when you die covers all the scenarios in detail.

Annuities are tax-deferred — not tax-free, with an important exception. For non-qualified annuities (funded with after-tax dollars), interest accumulates inside the contract without annual taxable income recognition, but that deferred gain becomes taxable as ordinary income when withdrawn. The LIFO (last in, first out) rule applies: gains come out first before cost basis is returned. The original premium (cost basis) is returned to the owner tax-free over time, but all growth above the original premium is eventually taxable. For qualified annuities inside IRAs or 401(k)s, the entire distribution is taxable as ordinary income because the deposited funds were never taxed.

The exception is Roth IRA annuities. An annuity held inside a Roth IRA follows Roth distribution rules — qualified withdrawals (after the account has been open for five years and the owner is at least 59½) are income-tax-free, including all growth. This combination of the annuity’s principal protection and guaranteed features with the Roth’s tax-free distribution treatment can be a powerful planning approach for specific situations. The broader practical point is that annuity tax planning requires understanding which type of account holds the annuity and the applicable distribution rules for that account type. Our resource on non-qualified annuity taxation and qualified annuity taxation cover the specific rules for each.

Required minimum distributions (RMDs) apply to qualified annuities held inside Traditional IRAs and other pre-tax retirement accounts just as they apply to any other qualified account asset. When a qualified annuity has not been annuitized, the RMD is calculated based on the account value and the IRS Uniform Lifetime Table (or Joint Life Table where applicable) in the same way as for other IRA investments. The annuity’s free withdrawal provision must accommodate the projected RMD amount — most well-designed annuity contracts allow RMD withdrawals without surrender charges, but this should be confirmed before purchase, particularly for older owners approaching RMD age with large contract balances.

When a qualified annuity has been annuitized — converted into a guaranteed payment stream — the scheduled payment amounts are evaluated against the IRS’s RMD requirements for that contract. If the annuitized payments satisfy the RMD rules (which they typically do when annuitization meets IRS requirements for “substantially equal periodic payments”), the scheduled payments are treated as satisfying the RMD for that contract. The annuity’s RMD does not combine with or replace the RMD for other IRA accounts — each account has its own RMD calculation, though IRA RMDs may be aggregated and satisfied from any combination of IRA accounts. Our resource on required minimum distributions and RMDs after SECURE 2.0 address the current rules in detail.

Annuities are not FDIC-insured. FDIC insurance applies to bank deposit accounts — checking accounts, savings accounts, money market deposit accounts, and CDs — up to $250,000 per depositor per FDIC-member institution. Annuities are insurance contracts, not bank deposits, and they are regulated and protected through an entirely different framework. The protection backing an annuity comes from the issuing insurer’s financial strength and claims-paying ability, supplemented by state insurance guaranty associations that provide a backstop for qualifying contracts within defined limits when an insurer becomes insolvent.

State guaranty association coverage limits for annuities vary by state — commonly $100,000 to $300,000 per owner per insurer — and should not be treated as equivalent to FDIC protection or relied upon as a primary reason to purchase from a financially weaker carrier. The practical risk management approach for large fixed annuity allocations is to work with carriers that have strong AM Best financial strength ratings, diversify across multiple highly-rated carriers to manage concentration risk, and keep each carrier’s balance within the applicable state guaranty association limit. Our resources on whether annuities are insured and whether annuities are FDIC insured explain the regulatory protection framework in detail.

Surrender periods are finite — they end at a contractually defined date, after which the full contract value can be accessed, withdrawn, or repositioned without any penalty. Common surrender periods range from 3 to 10 years for most fixed annuity and FIA products. Some shorter-term products (2- and 3-year MYGAs) are specifically designed for owners who want a brief commitment period with near-term liquidity. After the surrender period ends, the annuity is as liquid as any other financial account in terms of access to the full value — there are no ongoing surrender charges, no perpetual commitment, and no mechanism that keeps money “locked up” indefinitely.

During the surrender period, most contracts provide meaningful partial liquidity through annual free withdrawal provisions, hardship waivers, and in some cases required minimum distribution accommodations that allow access to specified amounts without penalty. Surrender charges that apply to excess withdrawals decline each year during the surrender period — typically from a higher percentage in year one toward zero in the final year — so the cost of full early access, while real, also diminishes as the contract ages toward maturity. The correct planning discipline is matching the contract’s surrender period to the intended holding period for the specific dollars being allocated, so surrender charges are an anticipated feature of the contract rather than an unexpected constraint. Our resource on annuity surrender charges and MVA explains how surrender schedules work and what to evaluate before purchase.

The inflation concern is most relevant for fixed income annuities — particularly immediate annuities with level (flat) payment amounts — where a fixed monthly payment of $2,000 today represents significantly less purchasing power after 20 years of even moderate inflation. This is a genuine consideration for income annuities used to cover essential retirement expenses over long time horizons, and it warrants explicit planning attention rather than dismissal. Several approaches address the inflation challenge within an annuity framework: inflation-adjusted SPIA options (where available) provide payments that increase annually at a defined rate — at the cost of a lower initial payment; fixed indexed annuities with income riders that continue crediting the benefit base during deferral can provide growing income potential; and portfolio integration strategies that pair guaranteed annuity income for essential expenses with growth-oriented assets for discretionary spending allow the portfolio’s growth component to address inflation while the annuity addresses income certainty.

The broader planning approach recognizes that “keeping up with inflation” is not the primary function annuities are designed to serve — they are designed to provide income certainty and principal protection. Growth assets (equities, inflation-protected bonds, indexed products) serve the inflation-fighting role in a diversified retirement plan. The annuity provides the guaranteed foundation that allows the growth assets to do their work without requiring the owner to sell at unfavorable times to fund essential expenses. Our resource on annuities with inflation protection covers the specific options available for addressing inflation within an annuity structure.

Non-qualified annuity contracts can be transferred to another annuity contract tax-deferred through a 1035 exchange under IRC Section 1035, which allows the direct transfer of one non-qualified annuity to another without recognizing accumulated gain as taxable income at the time of transfer. The 1035 exchange must be executed as a direct insurer-to-insurer transfer — the owner cannot take constructive receipt of the funds — and the receiving contract must qualify as an annuity under IRS rules. This mechanism makes it possible to move from a lower-yielding existing annuity to a new contract with a more competitive current rate, or to change product design (from a fixed annuity to an FIA, for example) without triggering a taxable distribution event.

Two important caveats apply. First, if the existing contract is still within its surrender period, surrender charges will apply to the transferred amount, reducing the net value moving to the new contract. The cost of these charges must be weighed against the benefit of the new contract to confirm the exchange is financially advantageous. Second, the new contract begins its own surrender period, so the owner must be comfortable with the new holding commitment. When exchange timing is planned around maturity dates — when surrender charges are zero — the 1035 exchange is typically cost-free and administratively simple. For qualified annuities inside IRAs, rollovers follow IRA rollover rules rather than 1035 exchange provisions, but the principle of tax-deferred repositioning applies.