How Does an Annuity Work? Plain-English Guide

The short answerAn annuity is a contract with an insurance company. You put money in, all at once or over time. It grows tax-deferred for a while (the accumulation phase). Later you can take withdrawals or turn it into a stream of income (the payout phase). The trade-off is that the money is less liquid; withdrawals beyond the free amount in the early years usually carry surrender charges.

The two phases

Accumulation. Your money earns interest based on the contract type; taxes are deferred until you withdraw.
Payout. You take withdrawals, or annuitize into regular payments for a period or for life.

A hypothetical example

Example numbers only

Hypothetical fixed annuity. Example numbers only, not a projection of any real product.

Starting amount	$25,000
Example rate	4% a year for the period
Years	5
Example value at end, before taxes	about $30,400

Hypothetical example for education only. It is not a quote or a recommendation for your situation.

Real rates, terms and surrender schedules vary by contract and change over time.

Things to understand before buying

Surrender charges and how long they last
The free withdrawal amount (often around 10% a year on many contracts)
Fees for optional riders
Withdrawals before age 59½ may face a 10% IRS penalty on earnings, plus income tax (California generally adds its own 2.5% early-withdrawal tax)
If you buy in California at 60 or older, a 30-day window after you receive the contract to return it for a refund

See hypothetical growth numbers

Our free projector shows how savings could grow under example rates. Hypothetical only, not a quote or a promise of future results.

Open the annuity projector

Related free tools

Family needs analysisAdd up debt, income, mortgage and education to get your own coverage number.FAST calculatorSee where money leaks each month and what you could redirect toward protecting your family.Mortgage coverage calculatorStart with your loan balance and monthly payment.

Common follow-up questions

Are annuity earnings taxed?

Growth is generally tax-deferred; withdrawals of earnings are taxed as ordinary income.

What is annuitizing?

Converting your balance into regular payments, for a set period or for life.

What happens to my annuity when I die?

Many contracts pay the remaining value to your beneficiaries. Payout options vary.

Can I lose money in an annuity?

Fixed and fixed indexed annuities aren't exposed to market losses, but surrender charges can reduce what you get back if you leave early.

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How does an annuity work, in plain English?