Annuities Explained: How Income Annuities Pay, What Fees Can Apply, and Questions to Ask

An annuity is a contract with an insurance company. You pay money in. The company pays money back out over time. An income annuity is the kind built to send you a steady payment, often for the rest of your life.

This guide explains how income annuities pay, what fees and charges can apply, and the questions to ask before you sign. No rates or payout amounts are given here. What a contract pays depends on the company, the contract, your age, and the choices you pick. The only figures that count for you are the ones in a written quote with your name on it. Our Paying for Care section holds our other cost guides.

How an income annuity pays

You pay the company one lump sum, or a set of payments over time. In return, the company agrees to pay you on a set schedule. Payments can come each month, each quarter, or each year.

An immediate annuity starts soon. The National Association of Insurance Commissioners (NAIC) states that an immediate annuity is bought with one payment and starts to pay within one year. A deferred annuity starts later. Your money sits in an account phase first, and the payment phase starts on the date you pick.

You also pick the span of the payments. One choice pays for a fixed number of years. One pays for your whole life, so the checks do not stop while you live. One pays over two lives, so a spouse keeps getting checks after the first spouse dies. A longer span means a smaller payment for each check, because the same money is spread over more time. A life span guards against outliving your savings, and it means the company may pay for far more years than you paid in, or for far fewer if you die early. Some contracts add a clause that pays any money left to your family if you die in the first years. That clause costs something, and it cuts the size of each check.

Fixed annuities promise a set interest rate and a payment that does not change. Variable annuities put your money in market accounts, so the value and the payments can go up or down. Indexed annuities tie growth to a market index, with limits set in the contract. The word guaranteed means the insurance company backs the promise. It is only as strong as that company, so check the company before you buy.

What fees and charges can apply

Contracts differ, so this list names the kinds of costs to look for. The contract in front of you is the source for which ones apply to you and how each one works.

Many contracts allow a small free withdrawal each year with no surrender charge. Ask how much, and what happens if you need more in one year for a health bill or a home repair.

• Surrender charges. If you take out more than the contract allows in the first years, or you end the contract early, the company can take a charge. The NAIC Buyer's Guide states that the charge may be a share of the contract value, of the premiums you paid, or of the amount you take out. The charge tends to fall over time and can reach zero after a set number of years.
• Contract and transaction fees. Some contracts charge a flat fee each year, or a fee per payment or trade.
• Rider costs. Add-on benefits, such as a death benefit or a promise of minimum income, can carry their own yearly cost.
• Limits on growth. Indexed and variable contracts can cap gains or take a share of gains. A cap is not called a fee, but it still cuts what you earn.
• Tax costs. Growth inside an annuity is not taxed until you take money out. Early withdrawals before age 59 and a half can also draw a federal tax penalty. Ask a tax advisor how the rules fit your case.

Who pays for what

• Medicare does not pay annuity premiums and does not sell annuities. Medicare pays for health care.
• Medicaid: money in an annuity can count in Medicaid resource and income tests, and the rules are strict and vary by state. If Medicaid may be part of your plan later, ask your state Medicaid office or an elder law attorney how a contract counts before you buy one.
• The insurance company pays the income payments in the contract, on the schedule and for the span you picked.
• Private pay: you pay the lump sum or the premiums, and you bear the fees and charges in the contract you signed.

Sample situation

Robert is 68 and has just retired. A seller offers him an income annuity and tells him the monthly payment will never drop. Robert asks for the full quote in print. The papers show the payment is set for his life span, with no payment to his wife if he dies first. They also show a surrender charge if he takes out more than the free amount in the first years. Robert asks for a second quote that pays over both lives. The check is smaller, but his wife would keep an income if he dies first. He takes both quotes home, checks that the company is licensed in his state, and signs nothing that day.

Questions to ask before you sign

• Is this an immediate annuity or a deferred annuity, and on what date do payments start?
• How long do payments last: a set term, my life, or two lives? What does my family get if I die early?
• What are all the fees, rider costs, and surrender charges, and in which year does the surrender charge reach zero?
• How much can I take out each year with no charge, and what happens in an emergency?
• Can I change my mind? Most states give a free-look period after you get the contract. Ask how many days yours gives and how you cancel in that window.
• Is the company licensed in my state, and what is its financial strength rating?

Sources

• https://content.naic.org/insurance-topics/annuities