Annuities earn returns, but not through interest the way a savings account does
An annuity does not sit in a bank account collecting interest. Instead, the money you put into an annuity is invested — usually in stocks, bonds, or a mix of both — and the annuity's value grows (or shrinks) based on how those investments perform. The growth is called a return or gain, not interest. With some annuities, the insurance company guarantees a minimum return. With others, your return depends entirely on market performance, which means you could lose money.
The confusion happens because both savings accounts and annuities can grow your money over time. But the mechanism is different. A savings account earns interest — a set percentage the bank pays you. An annuity earns returns — gains or losses from the underlying investments, plus any guarantees the insurance company has written into the contract.
Key Takeaways
- Fixed annuities may provide a set return rate for a specific period, similar to how interest works, but the rate is set by the insurance company, not a bank.
- Variable annuities grow based on the performance of the investments you choose, so returns can be higher or lower than expected, and you can lose principal.
- Indexed annuities tie returns to a stock market index like the S&P 500, with a may provide minimum return and a cap on how much you can gain in any year.
- The return rate on any annuity depends on the type, the insurance company's terms, market conditions, and how long you hold the contract.
Fixed annuities: may provide returns that work like interest
A fixed annuity is the closest thing to an interest-bearing account. The insurance company promises to pay you a set return rate for a set period — often three, five, seven, or ten years. During that time, your money grows at that rate regardless of what happens in the stock market. When the period ends, the rate resets, and you can renew the contract at a new rate or move your money elsewhere.
The rate is determined by the insurance company based on what it earns from its own investments, current interest rates, and competition with other insurers. Rates vary by company and by how long you lock in your money. A ten-year fixed annuity typically pays more than a three-year one because you are giving up access to your money for longer. The insurance company publishes these rates, and you can compare them across providers before you buy.
One key difference from a savings account: if you withdraw money before the contract period ends, you usually pay a surrender charge — a penalty that can be 5 to 10 percent of your withdrawal, depending on the contract. This is how the insurance company protects itself when rates are locked in.
Variable annuities: returns tied to your investment choices
A variable annuity does not offer a may provide return. Instead, you choose how to invest the money — typically from a menu of mutual funds or similar options the insurance company offers. Your return depends on how those investments perform. If the stock market rises and your chosen funds gain value, your annuity grows. If the market falls, your annuity can lose value, including principal.
Variable annuities often come with optional guarantees you can add, called riders. A common one is a may provide minimum return — the insurance company promises that even if your investments lose money, your annuity will grow by at least a small percentage, often 1 to 3 percent per year. These guarantees cost extra, usually 0.5 to 1.5 percent of your account value each year, and they reduce your potential upside.
Because variable annuities depend on market performance, there is no single "return rate" you can compare across companies the way you can with fixed annuities. Instead, you compare the investment options available, the fees charged, and the optional guarantees offered.
Indexed annuities: returns capped but with a floor
An indexed annuity sits between fixed and variable. Your return is tied to the performance of a stock market index — usually the S&P 500, but sometimes the Nasdaq or other indexes. The insurance company guarantees a minimum return, often 0 to 2 percent per year, so you will not lose money even if the index falls. But it also sets a cap on how much you can gain in any year, often 4 to 8 percent, even if the index rises more than that.
The cap protects the insurance company's profit margin. If the S&P 500 rises 15 percent in a year but your annuity is capped at 6 percent, you earn 6 percent. If the S&P 500 falls 10 percent, you earn the may provide minimum — say, 1 percent. This trade-off appeals to people who want market exposure but do not want to risk losing principal.
Indexed annuities also use different calculation methods — some measure the index's performance annually, others monthly or quarterly. These methods can significantly affect your actual return, so the contract details matter more than the headline cap rate.
How fees reduce the returns you actually receive
All annuities charge fees, and these fees reduce your net return — the amount you actually keep after costs. Fixed annuities typically have lower fees because the insurance company bears the investment risk. Variable annuities often charge 1 to 3 percent per year in management and administrative fees, plus the cost of any optional guarantees. Indexed annuities charge administrative fees, usually 0.5 to 1.5 percent per year.
Some annuities also charge surrender charges if you withdraw money early, and some charge annual maintenance fees. A few charge sales commissions that come out of your initial investment. These fees are disclosed in the contract, but they are not always straightforward to find or understand. Before you buy, ask the insurance company or agent for a clear breakdown of all annual costs as a percentage of your account value.
A fixed annuity paying 4 percent per year with 0.5 percent in fees nets you 3.5 percent. A variable annuity earning 6 percent in the underlying funds but charging 2 percent in fees nets you 4 percent. The stated return and the net return are not the same thing.
How long you hold the annuity affects total growth
Annuities are designed to be long-term investments. Most contracts have a surrender period — typically five to ten years — during which you can withdraw your money but pay a penalty. If you need the money before that period ends, the surrender charge can wipe out years of gains.
The longer you hold an annuity, the more time the returns have to compound. A fixed annuity earning 4 percent per year grows significantly more over twenty years than over five years. A variable annuity with market exposure has more time to recover from downturns. This is why annuities are usually recommended for people who do not plan to touch the money for at least five to ten years.
If you think you might need access to your money sooner, a regular savings account or money market account might be a better fit, even if the return is lower. The penalty for early withdrawal from an annuity can be steep enough to outweigh any return advantage.
Comparing annuity returns across different types
| Annuity Type | Return Source | may provide Minimum | Typical Return Range | Risk to Principal |
|---|---|---|---|---|
| Fixed | Insurance company promise | Yes, full amount | 2 to 5 percent per year | None |
| Variable | Your chosen investments | Optional (costs extra) | Varies widely; can be negative | Yes, unless may provide added |
| Indexed | Stock market index performance | Yes, usually 0 to 2 percent | Typically 3 to 8 percent per year | No, but gains are capped |
The "typical return range" shown above is based on historical averages and current market conditions, but past performance does not predict future results. Actual returns depend on the specific contract terms, the insurance company, and market conditions at the time you buy and hold the annuity.
Frequently Asked Questions
Can I lose money in an annuity?
It depends on the type. Fixed and indexed annuities may provide you will not lose principal. Variable annuities can lose value if the investments you chose perform poorly, unless you added a may provide rider. Even with a may provide, you might earn less than you would have in the stock market during a strong bull market.
What is the difference between annuity returns and CD interest rates?
A CD (certificate of deposit) is a bank product that pays a set interest rate for a set period, similar to a fixed annuity. The main differences: CDs are insured by the FDIC up to $250,000 per bank, while annuities are backed by the insurance company's financial strength. CDs typically have lower surrender charges or none at all. Fixed annuities often pay slightly higher rates because they are not FDIC-insured.
How often do annuity returns get credited to my account?
Fixed annuities usually credit returns annually or at the end of the contract period. Variable annuities credit returns daily as the underlying investments change value. Indexed annuities typically credit returns annually, though some use monthly or quarterly measurement periods. Check your contract for the exact crediting schedule.
Do annuities pay returns while I am waiting to start receiving payments?
Yes. During the accumulation phase — the period before you start taking payments — your annuity grows through returns or interest, depending on the type. Once you start receiving payments, the remaining balance may continue to grow, or it may be depleted depending on the payout option you chose.
What happens to my annuity returns if interest rates rise or fall?
Fixed annuity rates reset when your contract period ends. If interest rates have risen, new fixed annuities will pay higher rates, but your existing contract keeps its locked-in rate. Variable and indexed annuities are not directly affected by interest rate changes, though rising rates can reduce stock and bond values in the short term.