Information from the Washington State Department of Financial Institutions

The Basics of How Annuities Work

Share: Print

What Are Annuities?

Annuities are a type of insurance product that pays you income. Some people use annuities as part of a retirement strategy.

How Do Annuities Work?

  • You pay either a single premium or make payments for a set period of time in exchange for a future income.
  • They should increase in value and be income-tax free.
  • You can request to receive payments in a lump sum or in periodic fixed amounts.
  • A popular payout option is "lifetime income with 10 years certain." This means the annuity pays a monthly income for the life of the annuitant or for 10 years, whichever is longer.

Annuities Fees

There are fees and charges you must pay annually. Before you buy, make sure you understand and ask questions about the fees and charges.

Annuity expenses can be 3 percent or more per year. Make sure you understand all the fees and charges before you buy.

Annuities fees often include:

  • Surrender charges - If you cancel or cash out the policy early you must pay a surrender charge. This charge is typically highest in the early years of the annuity and may be reduced or eliminated over time. Surrender charges commonly range from 5 to 25 percent of the amount withdrawn. The average surrender charge period is seven years.
  • Mortality expenses - This is a fee charged by the insurance company to provide you with a death benefit on the contract.
  • Administrative expenses - Many policies have a separate administrative fee to cover the costs of mailings and ongoing service.
  • Investment-expense ratio - The underlying stock or bond account (variable annuities) will have an annual investment management fee.
  • Additional costs of riders - Riders are extra features on your policy that provide you with additional guarantees or death benefits.

Where To Learn More About Annuities