Annuities: Fixed vs. Variable vs. Indexed — Do You Need One?

7 min read

Retirement Planning

Few financial products are sold harder and understood less than annuities. An annuity is, at its core, a contract with an insurance company: you hand over money now (or over time) in exchange for a stream of payments later. Done right, an annuity is a longevity hedge — insurance against outliving your money. Done wrong, it's a high-fee product that enriches the seller.

The Two Big Families

Immediate annuities start paying you right away. You give a lump sum (say $300,000), and the insurer pays you a guaranteed monthly amount for life. This is the classic "pension you can buy" — the insurance company takes on your longevity risk.

Deferred annuities grow your money first, then pay out later. This is where most of the complexity — and most of the sales pressure — lives.

The Main Deferred Types

Fixed annuity: The insurer guarantees a set interest rate for a period. A MYGA (multi-year guaranteed annuity) is essentially a "CD from an insurance company" — a fixed rate for a fixed term, with an early-withdrawal penalty. Simple and easy to compare.
Variable annuity: Your money goes into investment sub-accounts (like mutual funds), so returns vary. This is where fees get steep — often 2–4% per year once you add mortality charges, rider fees, and fund expenses.
Indexed annuity: Returns are tied to a stock index (like the S&P 500), but with a floor and a cap. You participate in some of the upside while the insurer absorbs some of the downside. The catch is in the fine print: "participation rates" and "caps" quietly limit how much of the index's return you actually keep.

The Math Problem

Annuities sell a feeling — guaranteed income you can't outlive — and that feeling has real value. But it comes at a price:

Fees. Variable and indexed annuities frequently carry 2–4% in annual costs. Over 20 years, 3% in fees turns $100,000 into $180,000 instead of $240,000.
Surrender charges. Deferred annuities typically lock you in with penalties (often 7% or more) for the first several years. Getting your money back early is expensive.
Complexity. Indexed annuities especially are engineered so the average buyer can't compare them to alternatives.
Ordinary income taxation. Annuity gains are taxed as ordinary income, not at the lower capital gains rate.

When an Annuity Actually Makes Sense

For a small subset of people, annuities solve a real problem:

You have no pension and fear outliving your money. A simple immediate annuity (or income rider) can function as a DIY pension. This is a legitimate use — converting a lump sum into guaranteed lifetime income reduces sequence-of-returns risk.
You want a fixed rate with tax deferral. A MYGA can beat CDs in some rate environments, and the interest grows tax-deferred.
You're high-fee-averse and buy a plain product. A simple fixed or immediate annuity, purchased without a salesman's add-ons, can be reasonable.

When to Walk Away

You already have Social Security and a pension. You may already have plenty of guaranteed income.
The product is being pitched with a free dinner. High-commission products find their buyers over steak.
You can't explain, in one sentence, how the return is calculated. If the mechanics are opaque, the fees usually are.
You're decades from retirement. You don't need an annuity's guarantees yet — and the fees will eat decades of growth.

The Bottom Line

An annuity is a tool, not a scam — but it's a tool sold with unusual aggression because it pays unusual commissions. The simple versions (fixed, immediate, MYGA) can genuinely help retirees sleep at night. The complex ones (variable, indexed) are where most of the value leaks out in fees. If you're considering one, compare it against the boring alternative: a diversified portfolio and a sensible withdrawal rate.