What is an annuity
An annuity (Polish: annuitet), in its basic form, is a capital annuity, also called “annuita” in Polish. When you buy an annuity, you sign a contract under which you deposit money with an insurance company in exchange for future payments. The company invests these funds, and when the annuity’s term ends, it pays you a regular income for an agreed period or for the rest of your life, while taking on the risk that the capital will run out early. That is why annuity programs are most often used as retirement security.
There are fixed-rate and variable annuities. The latter may invest in the stock market. None of them are government-guaranteed, because they are issued by insurance companies. I describe in detail how annuities work in the book “Amerykańskie emerytury” (“American Pensions”).
Advantages of an annuity
An annuity is a suitable instrument for accumulating money over the long term for your later years, thanks to several advantages.
- The capital in an annuity grows tax-deferred. Withdrawn contributions are not taxed, and earnings are subject to income tax in the year they are paid out.
- After the capital is converted into a stream of annuity payments, the insurance company will pay us a lifetime income. Thanks to this, our money will never run out, even if we live for many years.
- As long as the earnings remain in the annuity, they are not taxed and are not counted in the income that determines whether Social Security benefits are taxed. The taxable part of the annuity payments received later, however, will count.
Example: After a single payment of $100,000, a 65-year-old man can receive a lifetime income of several hundred dollars a month. The payments depend on many factors: the owner’s age and sex, the number of guaranteed years, and whether payments begin right away (immediate annuity) or are deferred (deferred annuity). An annuity paid until the death of the second spouse is lower.
The U.S. Securities and Exchange Commission (SEC) also explains how annuities work on its website investor.gov.
Disadvantages of annuities
Annuity contributions are not tax-deductible, which is why annuities are sometimes put inside retirement accounts to get that deduction.
Annuities are expensive. Their fees for money management and insurance average 2.1 percent – twice as much as the average mutual fund and 10 times the cost of owning the Vanguard Index 500 index fund. Because of these costs, it takes about ten years before the benefits of tax deferral begin to offset the high fees and the annuity starts to pay off. In addition, earnings withdrawn before age 59 and a half are subject to a 10 percent penalty.
Annuities tie up your money for a long time. Cashing in an annuity early carries a penalty – a surrender charge, which is usually 7 percent in the first year and drops to zero after seven years.
Annuities are not government-insured. Although they are sold in banks, they are not bank products but insurance products. Variable annuities are invested in the stock market, which makes their value fluctuate.
An annuity is a complicated product, which makes it hard to compare options and choose the most suitable one. Talk it over with an unbiased financial advisor.
Why annuities are popular
Annuities are more popular than ever – hundreds of billions of dollars’ worth are sold in the U.S. every year. The reason is that annuities are the most lucrative product for insurance agents and financial advisors, who can earn a commission of 4–7 percent of the money invested.
The North American Securities Administrators Association considers the unsuitable sale of annuities to be one of the most serious traps for investors. An army of brokers, investment advisors and insurance agents eagerly sells annuities, convincing clients that they are like an IRA, only better, because there is no limit on contributions and the money can be left in them for any length of time, growing tax-deferred.
Who is an annuity for?
An annuity is suitable above all for someone who wants to turn a large sum into an income paid until his or her death or the spouse’s death, to supplement Social Security retirement benefits. With an annuity we can be sure that we will not run out of money. Unfortunately, only one percent of these products are used for that purpose.
An annuity is good for younger people in a high tax bracket who have already contributed the maximum to retirement plans (IRA, Keogh, 401(k), etc.) and are looking for an additional tax shelter for their investments.
People who are afraid of lawsuits are also candidates for annuities. Three-quarters of the states (including New York, Washington, Florida and Texas) protect variable annuities from creditors. That is why business owners or doctors worried about malpractice suits are keen to protect their assets in annuities.
Was an annuity good for Ms. Jadwiga?
Which of the categories above does Ms. Jadwiga fall into? None. She is nearing seventy, so she does not have time for her money to accumulate substantially. She does not pay taxes, so she does not need a tax shelter. She wants to return to Poland soon and buy an apartment there with her savings, so she needed a liquid investment. Now she will have to break her contracts with the insurance company and pay penalties that will probably eat up any earnings.
The bottom line: If a nice bank employee tries to talk you into an investment you do not understand, take all the papers home and read them carefully.
Updated October 2026.
