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What Is an Annuity?

Marianne Hayes
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Quick Answer

An annuity is a contract you make with an insurer that can provide guaranteed cash disbursements in retirement. They come in several shapes and sizes, but annuities are designed to prevent people from outliving their money.

<p> Everyday expenses—including gasoline, groceries, rent, transportation and utility bills—grew at a pace not seen in decades in 2022. Feeling the effects, 2 in 5 Americans say they are having a hard time making ends meet, according to U.S. Census data.</p><p> Experian examined data from the Census Bureau's <a href=Household Pulse Survey to evaluate which states had the largest share of adults who reported having difficulty paying for typical household expenses at the start of November 2022. In the event of a tie, the state with the higher number of people struggling was ranked higher in this list.

The Household Pulse Survey has been used to measure the impact of the COVID-19 pandemic on U.S. households since April 2020. The survey asks Americans about a range of pandemic-related issues including vaccination status, physical and mental health, and their ability to meet their financial obligations. As of the date this analysis was written, the survey’s most recent collection period ended on November 14, 2022.

An above-average percentage of Americans in 16 states, many where residents make below the U.S. per capita income, reported they struggled to afford their usual bills in November.

Though inflation has slowed, the Federal Reserve has indicated it will continue raising interest rates to combat it. By November, prices rose 7.1% over the same month in 2021, meaning the cost of goods and services continues to increase at more than three times the speed it typically does. The main drivers of that inflation are energy and food costs, according to the Census Bureau.

And there's reason to believe it might remain difficult for some Americans to comfortably afford regular expenses.

In September, Federal Reserve Chair Jerome Powell indicated that by raising interest rates, the central bank hoped to halt inflation by creating an economic environment in which wage growth slows and Americans spend less. Policymakers believe consumer spending is a major factor contributing to the current rise in the prices of goods and services.

Percentage of Adults Who Say They Can’t Afford Household Expenses

National Outlook: Southern States Are Among Those Struggling the Most

More Americans living in Southern states, including Mississippi, Alabama, Louisiana and Texas, as well as Nevada and New Mexico, struggled to afford regular expenses the most, according to the Census Bureau's latest survey.

Consumers in Washington, D.C.; Oregon; Nebraska and Minnesota showed the most resilience in their ability to afford rising costs than anywhere else.

10. Connecticut

  • Percentage of adults struggling to pay household expenses: 43.3%

In Connecticut, 43.3% of adults reported experiencing difficulty paying for regular household expenses. Though the state’s $85,198 per capita income is 30% higher than the national figure, it stayed mostly flat between the third quarter (Q3) of 2021 and Q3 2022, according to the Bureau of Economic Analysis (BEA). Wages for Connecticut residents have not risen enough to keep up with the inflation rate for all goods and services, which has topped 6.4% for the region over the past year.

9. Florida

  • Percentage of adults struggling to pay household expenses: 44.1%

In Florida, 44.1% of residents reported struggling to afford household expenses in August. The Miami-Fort Lauderdale-West Palm Beach area, the largest metropolitan area in the state, has seen inflation rates that exceed the national rate. In October, the Miami metro area saw the cost of all goods and services increase from the same period last year to 10.1%, while the overall country's rate dropped somewhat year over year.

8. Arkansas

  • Percentage of adults struggling to pay household expenses: 44.8%

In Arkansas, where the per capita personal income is $51,240 per year, food banks and pantries are seeing an uptick in visitors seeking help. Inflation has pushed a contingent of Americans "over the edge," the CEO of one food bank in the state said.

In November, Arkansas had an average employment rate of 3.7%, or about 49.4 million residents who were not part of its labor force. And as the state population has grown, a housing shortage has driven prices up. Those higher prices have pushed residents into rental units, driving up the median monthly rent to more than $1,300—an increase of more than 20% year over year.

7. Texas

  • Percentage of adults struggling to pay household expenses: 45.3%

Almost half of Texas adults reported at least some difficulty paying for typical household expenses in November as the state comes off of a period of increased consumer spending. Texas was one of the first states to lift occupancy restrictions and mask mandates for businesses and public gatherings during the pandemic.

Texans' purchasing power can be seen in the historical 26% surge in tax revenues collected by the state through August of this year, according to the state’s comptroller. At the same time, residents are footing the bill for years of underinvestment in power grid reliability, which has translated into energy bills this summer that are more than 70% higher than the year before, the Dallas Morning News reported.

As one of the most populous states, Texas has received a large amount of government stimulus since 2020. The state used it to support historically massive public assistance programs to help residents afford housing and utilities. A number of its programs began running out of already-appropriated funds and closed earlier this year.

6. New Mexico

  • Percentage of adults struggling to pay household expenses: 46.1%

New Mexico’s per capita income is $52,227 per year, which falls behind the Southwest region’s $60,324 per capita income. It’s also lowest among its Southwestern neighbors. In November, the state had an unemployment rate of 4.1%, with more than 38 million people off payrolls.

Inflation in the Mountain West region was 8.3% in November, the highest compared with other areas of the country. To help residents combat rising prices in 2022, the state issued economic stimulus checks of up to $1,500.

5. Alabama

  • Percentage of adults struggling to pay household expenses: 46.3%

Increased living costs across the country created a pinch for workers whose wages weren't growing nearly as fast. Still, that pinch is likely more acute in states like Alabama, where individuals' incomes were already below the U.S. overall per capita income. In Alabama, the per capita personal income was $50,762 annually—$14,874 less compared with the overall U.S. per capita income.

4. Nevada

  • Percentage of adults struggling to pay household expenses: 46.7%

Nevada’s tourism and leisure industries were hit hard after the onset of the pandemic, with social distancing guidelines keeping visitors—and their spending dollars—away from casinos, hotels and tourist attractions. However, by July 2022, Gov. Steve Sisolak announced that Nevada had added more jobs to its workforce than had disappeared with COVID-19. As of November, the state has since experienced a slowdown in job growth and clocks in with a 4.8% unemployment rate, which is 1.1% above the national average.

In Q1 2021, the state per capita income was $62,321, which has since declined. It inched up to $61,506 in November, a per capita income still below the beginning of 2021—and a change that falls far behind the region’s 8.3% inflation rate.

3. Oklahoma

  • Percentage of adults struggling to pay household expenses: 47.5%

As with other states where residents struggle most to afford household expenses, the per capita income in Oklahoma—$55,260—falls below that of the overall U.S. workforce. The state also suffered increased costs of living due to a shortage of affordable housing and out-of-state investors. In 2022, Oklahomans saw a jump in energy prices of more than 30% and food costs of more than 9%—highs not seen in 40 years.

The Regional Food Bank of Oklahoma also reported an increase in demand for its services from residents across the state—an uptick it started seeing climb in the spring, the group told Oklahoma news station KFOR-TV.

2. Louisiana

  • Percentage of adults struggling to pay household expenses: 49.1%

Nearly half of adults in Louisiana struggled to afford regular household expenses in August, per the latest Census Bureau data. While median home prices in the state started cooling in June, it seems like almost everything else is more expensive. In New Orleans, food bank Culture Aid NOLA reported that for the first time this summer, it had to turn people away and enforce food limits due to increasing demand and supply chain shortages. Wages have not kept up with rising prices, and even for those who received raises in the past 12 months, the region’s 7.4% inflation rate has likely completely flattened out bumps in paychecks.

1. Mississippi

  • Percentage of adults struggling to pay household expenses: 50.5%

Half of Mississippi residents struggled to afford usual household expenses in the current inflationary environment in November.

Residents here have increased banking activity in recent years, as evidenced by the surge in money flowing through banks in the form of direct deposits, wages, pandemic aid relief and other banking activity. The Mississippi Bankers Association reported that it had seen 15 years' worth of typical growth in money coming into the bank in just the past three years, thanks to pandemic-era stimulus funding.

There are groups in the state working to better understand why Mississippi has a below-average percentage of residents working or looking for work as businesses struggle to staff up.

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An annuity is an investment that's typically used to generate income in retirement. It's a contract you make with an insurer that can provide guaranteed cash disbursements in the future. They come in several shapes and sizes, but annuities are designed to prevent people from outliving their money.

An annuity can be one part of an overarching retirement planning strategy, but they aren't for everyone. Here's an explainer of how they work and who should consider investing in one.

How Annuities Work

Annuities are available through insurance companies, though some banks, brokerage firms and mutual fund companies also sell them. One benefit is that they provide tax-deferred growth. That means you won't pay taxes on investment gains until you withdraw the money, but you can expect to pay fees along the way. Costs vary depending on the type of annuity you purchase. (We'll break this down below.)

Annuities are commonly structured in one of two ways:

  • Accumulation annuities: These allow you to save for retirement. Some work sort of like a certificate of deposit (CD) or mutual fund. The goal is to put money in and net a return down the road. With an accumulation annuity, your premiums are invested and grow tax-deferred for a set period of time.
  • Income annuities: You can purchase this type of annuity with a single lump-sum payment or through a series of payments. After that, you'll receive periodic income payments for a predetermined amount of time. Some annuities provide guaranteed payments for the rest of your life.

When Do You Start Getting Payments From Annuities?

When your annuity payments begin depends on the type of annuity. With an immediate income annuity, you pay your premium upfront and begin receiving payments usually within one to 13 months. Deferred income annuities don't distribute payments until a predetermined point in the future. These future income payments are usually more than what you'd get with an immediate annuity.

What Happens to an Annuity When You Die?

If you have an annuity with a death benefit provision, your beneficiary can receive some portion of your benefit for a certain number of years. These details should be spelled out in your contract. Couples, for example, may opt for a joint-life death benefit. With this option, payments are generally higher when both people are alive. If the first person dies, the second person will receive a decreased amount.

How Do Taxes Work With an Annuity?

Your tax liability depends on whether your annuity is qualified or non-qualified.

  • Qualified annuities are purchased with pretax funds. You'll be taxed when you receive funds, and you must begin taking required minimum distributions at age 72.
  • Non-qualified annuities are funded with after-tax dollars. Only investment gains are taxable.

Do Annuities Have Fees?

Fees vary depending on the annuity type and insurer. Here's a typical breakdown, according to annuity provider Canvas.

Annuity Fees
Type of Annuity Typical Fees
Fixed annuity 1% to 3%
Variable annuity 4% to 7% or more
Indexed annuity 6% to 8% or more

Source: Canvas

According to the U.S. Securities and Exchange Commission, other charges might include:

  • Mortality and expense risk fee: This compensates the issuer for taking on risk. It's typically around 1.25% per year.
  • Administrative fees: This might be charged as a percentage of your account value or as a flat annual fee.
  • Withdrawal penalties: You'll likely be hit with a 10% IRS penalty if you withdraw money before age 59½.
  • Surrender penalties: Variable annuities have a surrender period, which is usually the first six to eight years. You'll likely be penalized if you sell or withdraw money during this time.
  • Underlying fund expenses: If your annuity includes underlying mutual fund investments, there may be additional fees.

You can also expect to pay more if you add special features to your annuity, like tacking on long-term care insurance or requiring a minimum income benefit.

Do Income Annuities Provide Cost-of-Living Adjustments?

Some annuities allow contract holders to add a cost-of-living rider. This will boost their annual payments to help them keep up with inflation. If you go this route, keep in mind that your insurer may reduce your monthly benefit before calculating your annual adjustment. Always read the fine print to be sure the numbers are compatible with your retirement income plan.

Types of Annuities

Fixed Annuity

With a fixed annuity, you can choose lifetime payouts or receive payments for a shorter time. This can be appealing to retirees who want a reliable return that isn't affected by the stock market. Its fees are also on the lower side when compared to other annuities.

Fixed annuities offer a guaranteed interest rate for a certain period of time, though the name can be misleading. According to the Financial Industry Regulatory Authority (FINRA), a fixed annuity contract could periodically change the interest rate based on current rates. (Again, be sure to read your contract carefully.)

Variable Annuity

The rate of return for a variable annuity fluctuates. If you invest in stocks, bonds or money market accounts through your annuity, you can expect your rate to go up and down alongside those markets. Variable annuities are similar to mutual funds when it comes to investment choices and features, but their tax-deferred growth and higher fees set them apart.

You'll pay premiums that are invested in subaccounts. The insurer then makes minimum payments back to you that are determined by your initial investment—plus any gains or losses. Returns are not guaranteed.

Indexed Annuity

Indexed annuities blend features of fixed and variable annuities. In terms of investment risk, they're right in the middle. They mix a minimum guaranteed interest rate with a second rate that's tied to a market index like the S&P 500.

Indexed annuities can be complicated for the average investor to understand. For example, the indexing methods used to calculate gains are often confusing and unclear. It's important to understand all the features of a particular indexed annuity before investing.

Pros and Cons of Annuities

Pros

Cons

  • Fees and penalties may apply, which can eat into your investment returns
  • Not all annuities offer guaranteed returns
  • Annuities are not insured by the FDIC or SIPC

Should You Invest in Annuities?

Investing in an annuity might make sense for someone looking for a steady stream of income in retirement. It can also be part of your estate plan and left to a beneficiary after you're gone.

Annuities often come with fees, so you'll want to make sure it gels with your greater retirement income plan. They also don't provide much in the way of flexibility. If you want to tap your funds early, you'll be penalized.

The Bottom Line

For some, an annuity is a worthwhile investment in retirement. After paying your premiums, you could have a guaranteed return waiting for you on the other side. Like anything else, annuities have their drawbacks and won't make financial sense for everyone.

Your financial strength is important, whether you're preparing for retirement or are still a long way out. Take advantage of free credit monitoring so you get notified of changes to your credit score or actions that need to be taken, keeping your financial profile solid.

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