What an Annuity Is, and What It Is Not

What an annuity is

An annuity is a contract between you and an insurance company. You pay in, either all at once or over time. In return, the company agrees to pay you, as a stream of income or as a sum later, under the terms of the contract.

Most annuities have two stages. While your money is growing, the annuity is in its accumulation stage. When you start taking regular payments, it is in its income stage. Some annuities skip the first stage and start paying soon after you buy them.

Fixed and fixed indexed annuities are insurance products, regulated by state insurance departments. Variable annuities are also regulated as securities.

The three main kinds

Fixed annuities

The insurance company credits a set interest rate for a set period. Your account value does not go down because the market does.^*

Fixed indexed annuities

Interest is credited based on how a market index performs, within limits set by the contract. Your money is not invested directly in the market. In a year the index falls, your account is credited no interest rather than a loss from the index.^* Fees for optional features and charges for early withdrawals can still reduce your value.

Variable annuities

Your money is invested in funds that rise and fall with the market, so your account can lose value. Variable annuities often carry higher fees. Mary does not sell them, because she puts stability first.

What an annuity is not

• Not a bank account. Annuities are not FDIC insured and are not bank or government guaranteed.
• Not money you can reach freely. Most contracts let you take out a set amount each year. Taking more in the early years usually means a surrender charge.
• Not a stock market investment, in the case of fixed and fixed indexed annuities.
• Not your federal pension. Confusingly, your FERS or CSRS pension is also called an annuity. That is a federal benefit. An annuity you buy is a private contract with an insurance company, and the two are separate.
• Not right for every dollar. Money you may need soon usually belongs somewhere you can reach it without a charge.

Why some people say “annuities are bad”

You may have heard that annuities are bad. People who say that usually have real concerns in mind:

• High fees, especially in some variable annuities with several optional features.
• Surrender charges that make it costly to get out early.
• Contracts that are hard to read and harder to compare.
• Sales pitches that put the product ahead of the person.

Those concerns are fair, and they are why the questions below matter. An annuity can be the right tool for part of a plan, or the wrong one. Seeing the difference is the point of a review.

Questions to ask before you buy any annuity

• How long is the surrender period, and what does it cost to leave early?
• What fees apply, including for any optional features?
• How is interest credited, and what limits apply?
• What exactly is guaranteed, and by which insurance company?^*
• How does it fit with my pension, my TSP, and Social Security?
• What happens to the money when I die, and who receives it?
• Is the agent licensed in my state, and how is the agent paid?

Annuities and your TSP

The TSP offers its own option to buy an annuity with part of your balance. Some people instead move part of their TSP into an IRA and use it to buy an annuity from an insurance company. Each path has its own tax rules, costs, and features, and some choices cannot be undone.

Before moving any TSP money, compare what you would give up with what you would gain, including the TSP's low costs. These are strategies to discuss, not decisions to make quickly.