Few financial products generate as much confusion — or as much strong opinion — as the annuity. They are oversold in some corners of the industry and reflexively dismissed in others. The reality is more useful: annuities solve specific problems exceptionally well, and they solve others not at all. Understanding what they actually are, how they are structured, and what legitimate purpose each type serves is the starting point for any honest evaluation.
The Framework: A Contract, Not an Investment Account
An annuity is a contract between you and an insurance company. You transfer a sum of money — or a series of payments — to the carrier, and in return the carrier promises either a future stream of income, a guaranteed accumulation of value, or some combination of the two. All such guarantees are subject to the claims-paying ability of the issuing insurance company. That promise is backed by the insurance company's general account: the pool of assets the carrier holds to meet its obligations to all policyholders.
Most annuities move through two phases. During the accumulation phase, your premium grows inside the contract — either at a guaranteed rate, linked to an index, or invested in market subaccounts depending on the product type. During the distribution phase, the accumulated value is converted into income, either as periodic withdrawals, a lump-sum surrender, or annuitization — the process of exchanging the contract value for a guaranteed income stream, typically for life or a defined period.
One critical distinction: annuities are insurance products, not bank accounts. They are not covered by FDIC insurance. For fixed annuities (those backed by the carrier's general account), your security rests on the financial strength of the insurance company itself. This is why carrier credit ratings matter, and why selecting a financially sound insurer is not optional.
Market Size: A $4 Trillion Asset Class
The annuity market is larger than most investors realize. According to LIMRA's 2023 U.S. Annuity Sales Survey, total annuity sales reached a record $385 billion in 2023 — a 23% increase over the prior year — driven largely by the rise in interest rates, which made fixed and indexed products meaningfully more competitive than they had been during the prior decade of near-zero rates.
Total U.S. annuity reserves held by life insurers exceed $4 trillion, making the annuity market roughly comparable in size to the entire U.S. mutual fund equity market. The growth in the last two years has been particularly notable in fixed indexed annuities — which crossed $90 billion in annual sales for the first time in 2023 — and in registered index-linked annuities (RILAs), the fastest-growing segment of the market.
Credit Ratings: Why Carrier Strength Is Non-Negotiable
When you purchase a fixed or fixed indexed annuity, your money goes into the insurance carrier's general account. Unlike a variable annuity's subaccounts — which are legally segregated from the carrier's assets — the general account is the same pool of capital the insurer uses to meet all its obligations. If the carrier becomes insolvent, your claim on that pool is the claim of a creditor, not a brokerage account holder.
This makes carrier financial strength a first-order consideration. The primary rating agencies for insurance companies are:
- AM Best — the insurance-specific rating agency; the most relevant for evaluating carrier stability. Ratings run from A++ (Superior) down through A+, A, A−, B++, B+, and below. For annuity purchases, an AM Best rating of A− or better is a reasonable minimum threshold.
- S&P and Moody's — the broader credit rating agencies also rate insurance company financial strength. Their scales (S&P: A+ through BBB−; Moody's: A1 through Baa3 for investment grade) provide a useful cross-check.
Tax Deferral: The Structural Advantage
The feature that justifies annuities in a tax-aware portfolio is deferred taxation. Inside a non-qualified annuity (one funded with after-tax dollars, outside of an IRA or 401k), gains accumulate without generating an annual 1099. There is no taxable event from dividends, interest, or capital gains distributions during the accumulation phase — the entire balance compounds uninterrupted until you take a withdrawal.
When you do withdraw, the taxation follows a last-in, first-out (LIFO) rule for non-qualified annuities: gains are deemed to come out first and are taxed as ordinary income. This is less favorable than the long-term capital gains rate — a meaningful cost for investors who would otherwise hold appreciated securities in a taxable account. Withdrawals before age 59½ also trigger a 10% IRS penalty on the taxable portion, mirroring the treatment of qualified retirement accounts.
There are no contribution limits on non-qualified annuities. An investor who has maxed their 401(k), IRA, and HSA can place any additional after-tax dollars into an annuity and continue deferring taxes on the growth. This is the primary use case: a tax-deferred wrapper for money that has nowhere else to go. It is not a substitute for maxing tax-advantaged accounts first.
One additional tax note: annuity assets do not receive a step-up in basis at death. Beneficiaries inherit the original cost basis and owe ordinary income tax on the accumulated gains — unlike appreciated securities in a taxable brokerage account, which step up to fair market value at the owner's death. This makes annuities less efficient as a wealth transfer vehicle compared to holding appreciated investments directly in a taxable account.
The Three Main Types
Annuities fall into three broad categories, each with a different risk-return profile and a different set of appropriate use cases.
1. Fixed Annuities (Including MYGAs)
A fixed annuity credits a guaranteed interest rate to your premium for a defined period. The most common form today is the multi-year guaranteed annuity (MYGA) — essentially a CD-equivalent issued by an insurance carrier rather than a bank. A 5-year MYGA might guarantee 5.20% annually for the full term, with the carrier bearing all investment risk. Rates reset at renewal, similar to a CD.
Fixed annuities are simple, predictable, and low-risk. Their appeal today is twofold: they often offer higher rates than bank CDs on a comparable term, and — critically — the growth is tax-deferred, unlike a CD which generates taxable interest each year regardless of whether you withdraw it. For an investor in a high tax bracket who wants safe, interest-bearing accumulation outside of a qualified account, a MYGA in a tax-deferred wrapper is a structurally sound choice.
The tradeoff is surrender charges for early access — typically 5–10% in the early years of the contract — and the fact that return of principal in any given year is not guaranteed beyond what the contract specifies. Read the surrender schedule carefully before committing.
2. Fixed Indexed Annuities (FIAs)
A fixed indexed annuity links your credited return to the performance of a market index — commonly the S&P 500 — but with a guaranteed floor, typically 0%. In a year when the index falls, your account value does not decrease (ignoring fees and rider charges). In a year the index rises, you participate in a portion of the gain, subject to a cap (e.g., your gain is capped at 10% regardless of the index return) or a participation rate (e.g., you receive 60% of the index return with no cap).
It is important to understand the mechanics: the carrier does not invest your premium in the stock market. Instead, the insurer places your premium in its general account and uses a portion of the interest earned to purchase call options on the index. The option payoff funds your credited return in up years; in down years, the options expire worthless, and the floor protection kicks in — your principal is intact, and you simply received 0% for that year. This is why FIAs carry no direct market risk on principal, but also why participation in upside is limited: the carrier's option budget constrains how much gain it can pass through.
FIAs are frequently sold with optional income riders — Guaranteed Lifetime Withdrawal Benefits (GLWBs) — that guarantee a minimum annual income for life regardless of account performance. These riders carry an additional annual fee (typically 0.90–1.25%) charged against the account value. They can be genuinely useful for retirees who want to floor their income against a specific spending need, but the fee drag and the complexity of the income base mechanics deserve careful scrutiny.
3. Variable Annuities and RILAs
A variable annuity invests your premium in subaccounts — pools that function like mutual funds — and your account value rises and falls with the actual market performance of those subaccounts. There is no floor on losses; in a severe bear market, the account value declines with the market. In exchange, you receive uncapped upside participation and the same tax deferral that fixed products offer.
Variable annuities are registered with the SEC and require a prospectus — unlike fixed products, which are regulated solely at the state insurance level. They carry mortality and expense (M&E) charges (typically 1.0–1.5% annually), plus underlying fund expenses and any optional rider fees, making their total cost structure significantly higher than a comparable portfolio of ETFs held in a taxable account. The justification for that cost is the tax deferral and, where applicable, living benefit guarantees.
RILAs are SEC-registered and are the fastest-growing segment of the annuity market — LIMRA reported over $47 billion in RILA sales in 2023. They are particularly suited to investors who want more upside than a FIA offers but prefer to limit — rather than eliminate — downside exposure compared to a pure variable annuity. Product structures vary significantly by carrier; the buffer size, cap, and index options are the primary variables to compare.
When an Annuity Actually Makes Sense
Annuities are not universally appropriate — they have real costs, real illiquidity, and real complexity. But there are specific situations where they fit cleanly:
- You've maxed all tax-advantaged accounts and have significant after-tax savings generating taxable income each year. The annuity's tax deferral eliminates that annual drag on unneeded distributions.
- You need guaranteed lifetime income beyond what Social Security provides, and you are unwilling to take on sequence-of-returns risk in a drawdown portfolio for a core spending floor.
- You want principal protection with some growth potential — a fixed indexed annuity can serve as a conservative core holding for capital you cannot afford to lose.
- You are in a high tax bracket today and anticipate a lower bracket in retirement, making the deferral and later withdrawal at a lower rate a genuine net benefit.
Conversely, annuities are generally unsuitable as the first stop for retirement savings, for investors in lower tax brackets where the deferral benefit is modest, or for capital that needs to remain liquid. Surrender charges can lock up principal for 7–10 years in some products — an important liquidity consideration for anyone who may need access to that capital.
The Rubiq Approach
At Rubiq, we evaluate annuities as a tool within a broader income and tax strategy — not as a default product or a revenue driver. Most clients do not need an annuity. Some do. The distinction comes down to the specific income gap they are solving, the tax environment they are in, and whether the product's cost structure is justified by the benefit it delivers.
When annuities are appropriate, we focus on the simplest product that solves the problem: often a MYGA for short-term tax-deferred accumulation, or a straightforward FIA with no riders for clients who want a 0% floor on a portion of their portfolio. We approach income rider analysis with particular scrutiny — the gap between the "income benefit base" growth rate printed in marketing materials and the actual cash value of the contract is a source of significant confusion, and we model both before making a recommendation.
We use IncomeLab to model the income and tax implications of annuity distributions alongside Social Security, required minimum distributions, and other income sources — quantifying exactly what each product costs and what it delivers in the context of a client's full retirement picture. The goal is always the same: the right tool for the right problem, sized appropriately, at the lowest cost that achieves the objective.
