Annuity

An annuity is a contract with an insurance company. You hand over money, either at once or over time, and in exchange the insurer promises to pay you back on a schedule — often for the rest of your life. That longevity protection is the thing an investment portfolio cannot provide on its own.

The simplest version is the immediate annuity: a lump sum today buys a fixed monthly payment starting now. Deferred annuities grow first and pay later, and come in fixed, indexed, and variable flavors that differ in who carries the investment risk.

Complexity and cost rise sharply from there. Variable and indexed annuities layer on mortality-and-expense charges, administrative fees, underlying fund expenses, and riders, and they typically impose surrender charges that fall away over several years. Total annual costs running several percent are common, which is a heavy drag against a low-cost index fund.

The tax treatment is a genuine advantage and a genuine catch. Growth is tax-deferred with no annual contribution limit, but withdrawals of gains are taxed as ordinary income rather than at long-term capital gains rates, and money taken before 59½ generally carries a 10% penalty.

The honest use case is narrow: converting part of a portfolio into guaranteed income for someone who has covered the basics elsewhere and wants a floor under their spending. Because commissions on these products are large, it is worth asking whether the person selling one is a fiduciary.