What’s the Primary Reason People Buy an Annuity? Guaranteed Income

Why guaranteed income matters this much

An annuity is fundamentally a contract, not an investment — you transfer a lump sum or series of payments to an insurance company, and in exchange, the insurer takes on longevity risk: the risk that you'll live longer than your savings would otherwise support. If you retire at 65 with $1 million and withdraw $50,000 a year, that money runs out around age 85. If you live to 95 instead, a decade of expenses has no source. An annuity converts that uncertainty into a guaranteed paycheck that continues regardless of how long you actually live — the insurer absorbs the risk that you'll live "too long" for your savings, in exchange for the premium you paid upfront.

No other mainstream retirement product makes this exact promise. Social Security provides a guaranteed income base, but for many retirees it doesn't cover the full gap between fixed expenses and available savings. A well-structured annuity is specifically designed to close that remaining gap with the same kind of guarantee.

This is also why annuities come up so often in retirement conversations that otherwise focus on Medicare and healthcare cost planning — a predictable income floor makes it meaningfully easier to budget for fixed monthly premiums, whether that's a Medigap policy, Part D drug coverage, or ongoing out-of-pocket costs, since those bills arrive on a schedule regardless of what the broader market is doing in any given month.

The liquidity tradeoff: surrender charges

Guaranteed income doesn't come free — the insurer needs your money committed for a meaningful period to fund that long-term promise, which is why nearly every annuity includes a surrender period, typically three to ten years depending on the product type. Withdraw more than the allowed penalty-free amount during that window, and a surrender charge applies — commonly starting around 7% in the first year and declining gradually until it reaches zero at the end of the surrender period.

The length of the surrender period isn't arbitrary, and it tends to correlate with the type of guarantee involved. Multi-year guaranteed annuities and simpler fixed products often carry shorter surrender periods of three to five years, since the insurer's obligation is comparatively straightforward. Fixed index annuities frequently run longer, seven to ten years, reflecting the more complex guarantees layered into those contracts. Generally speaking, a longer surrender period correlates with a higher guaranteed rate or richer benefit — the insurer is willing to offer more in exchange for a longer commitment of your capital.

On a $200,000 annuity, a full surrender in year one at a 7% charge means a $14,000 penalty, on top of any income tax owed on accumulated gains, and a separate 10% IRS early withdrawal penalty if you're under 59½. Most contracts do allow penalty-free withdrawals of up to 10% of account value per year even during the surrender period, and many waive the charge entirely for events like nursing home confinement, terminal illness, or death — but outside those specific exceptions, your principal is genuinely illiquid for years at a time.

The fee tradeoff

Fees vary enormously by annuity type, and this is where doing real homework matters most. Fixed annuities and multi-year guaranteed annuities (MYGAs) are relatively simple and low-cost, with the guaranteed rate itself functioning as the main "cost" to you in the form of a lower return than you might get elsewhere. Variable annuities are a different story: they're regulated as securities by the SEC, and can carry mortality and expense risk charges, administrative fees, underlying fund management fees, and separate charges for optional riders like a guaranteed lifetime withdrawal benefit — combined costs that can run well over 2% annually in some products.

Commissions add another layer worth knowing about, even though you don't pay them directly out of pocket. Some variable annuity products carry commissions of 5% to 8% — among the highest in financial services — built into the product's cost structure. This creates a real incentive for some salespeople to recommend annuities even when a simpler, lower-cost alternative might genuinely serve you better, which is exactly why working with a fee-only fiduciary advisor, or at minimum asking directly about commission structure, is worth doing before committing.

None of this means every annuity is overpriced or every commission-based sale is a poor fit — a properly structured fixed annuity purchased for genuine guaranteed-income needs can be entirely reasonable even with a modest commission built in. The point is simply that fees and commissions vary widely enough between products that assuming any two annuities cost roughly the same is a mistake worth avoiding, and getting a full, written breakdown of every fee before signing is a reasonable ask of any advisor or agent presenting a specific product.

The real upside beyond income: tax deferral

It's worth balancing the tradeoffs above with a genuine, often-overlooked advantage: earnings inside a non-qualified annuity grow tax-deferred, with no annual IRS contribution limit the way an IRA or 401(k) has. A high earner who's already maxed out qualified retirement accounts can direct $500,000 or even $1 million into a non-qualified annuity in a single year and let it grow without annual taxation until withdrawal. For someone in this specific situation — high income, already maxed on tax-advantaged accounts, genuinely long time horizon — this tax-deferral benefit is a real reason to consider an annuity independent of the guaranteed-income question entirely.

This same audience — business owners and high earners planning around wealth-building strategies more broadly — often weighs an annuity's tax-deferred growth against similar advantages available through certain life insurance structures. The two products solve genuinely different problems (guaranteed income versus a death benefit with cash value access), but both share the tax-deferral mechanic, which is exactly why a comprehensive retirement or estate plan often benefits from comparing them side by side rather than evaluating either in isolation.

Who this tradeoff genuinely fits

Annuities tend to make the most sense for retirees who specifically want guaranteed income to cover fixed, non-negotiable expenses — housing, utilities, food — regardless of market conditions; conservative investors who prioritize principal protection over growth potential; people with a specific reason to expect a long lifespan, such as family longevity history; and high earners who've already maxed out other tax-advantaged retirement accounts and want additional tax-deferred growth.

Business owners planning their own retirement alongside their company's benefits, including anyone who's set up small business health coverage for a team, sometimes fall into this category as well, particularly if the business itself generated enough income in strong years to fully fund tax-advantaged accounts and still have surplus available for additional tax-deferred growth outside those accounts.

Who it usually doesn't fit

Annuities tend to make less sense for younger investors with a long time horizon who can absorb market volatility and don't yet need guaranteed income, anyone who might need access to their full principal within the surrender period, and investors already in a low tax bracket, where the tax-deferral advantage is minimal since they aren't paying much tax on investment gains in the first place regardless of account type.

Questions to ask before you buy

• What's the exact surrender period and charge schedule for this specific product?
• What are all the fees — mortality and expense, administrative, rider costs — added together?
• What commission is built into this product, and is the person recommending it a fee-only fiduciary?
• What penalty-free withdrawal amount is allowed each year during the surrender period?
• Does this product include a death benefit, or does remaining value go to the insurer if I die early?
• How does this fit alongside life insurance in my broader retirement and estate plan?

Common questions about why people buy annuities

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