Demystifying Annuities: A Clear Guide for Modern Investors
By Scott Hefty, Senior Wealth Manager and Founding Partner at Serae Wealth
Annuities are not for everyone. For the right person, in the right situation, with the right structure and a strong company behind it, they can be valuable tools for creating long-term stability, financial security, and peace of mind.
Successful planning is about more than growing wealth. It’s about aligning your resources with the life you want to build and the legacy you hope to leave. Annuities are often misunderstood, so our goal is to bring clarity to how they work and where they may (or may not) fit within a thoughtful plan. Before recommending any annuity, we help clients look forward, not just to the next market cycle, but to the next season of life. When you Think in Decades™, the question becomes: Does this tool support the future you’re building?
An annuity is a contract with an insurance company. It’s designed to create future income, protect principal or generate tax-deferred growth. Its value depends entirely on your investment goals and how it can support them. If your investment goals include the following, you might consider an annuity:
- Income you can’t outlive
- Protection from market loss
- Predictability
- Tax deferral on gains
Annuities are tools, not solutions on their own. Their value comes from how well they align with your goals and the role they play within a thoughtful plan. Understanding the differences between annuity types is important because each one is designed to address something specific within your overall strategy.
Before deciding whether an annuity makes sense, it helps to understand the main types available and what each is designed to provide.
There are four types of annuities: Fixed annuities, which offer predictable interest, providing stability and clarity around future values. Fixed indexed annuities, which provide principal protection while linking potential gains to market indices, and which offer a middle ground between safety and growth opportunity. Variable annuities, which give direct market exposure through sub-accounts, which means higher risk with greater growth potential. And, Immediate annuities, which start paying income right away, converting a lump sum into guaranteed payments for life or a specific period.
At Serae, we lead our clients to Think in Decades™, so before considering an annuity as a tool in their portfolio, we ask them to look ahead. If it is right for them, which type of annuity serves the life they’re building and the legacy they hope to leave?
Each type of annuity carries different fees, which can be confusing, so it’s important to understand and ask what the fees are and exactly what they include. Fees are not necessarily a negative. Most cover aspects of the annuity that provide real value such as protection or income guarantee. If they don’t or can’t be explained, they aren’t worth paying. A good, professional wealth advisor should explain annuity fees in a way that is transparent, purposeful and shows how they are aligned with the benefit received.
Fees are not the enemy, confusion is. The goal is to understand what you’re paying for and why.
Product fees include mortality and expense charges, administrative fees, and rider costs. These cover the insurance company’s guarantees and operational expenses.
Strategy and market exposure fees vary by the type of annuity. Variable annuities have sub-account fees similar to mutual fund expenses. Indexed annuities build in spreads, margins, participation rates or cap costs that affect potential returns.
Benefit Riders are optional features that enhance basic annuity contracts. Their purpose is to solve specific problems. Common riders include:
- Lifetime income riders that guarantee a minimum income stream regardless of market performance
- Enhanced death benefits that protect heirs
- Long-term care or chronic illness riders that provide accelerated access to funds for healthcare needs
- Return-of-premium features that ensure beneficiaries receive at least what was paid into the annuity at the start of the contract
- Guaranteed accumulation riders that lock in minimum growth rates.
The key difference is that riders add guarantees, which come with a cost. Only choose riders when they serve a clear purpose in your financial plan. The annuity won’t improve by adding features you don’t need, and it will only make it more expensive.
Other fees to be aware of include renewal rates and ongoing terms, which are often misunderstood and where many investors feel misled. Fixed interest renewal rates can change after initial guarantee periods end, meaning what is earned in the first year may not be what is earned the fifth year. Index strategy renewal terms including caps, spreads and participation rates can be adjusted by the insurance company, but these changes can directly affect potential returns.
Know which items within the contract are guaranteed versus non-guaranteed and subject to change. Also be certain of how often companies can change terms. Some allow annual changes and others lock in terms for multiple years.
We recommend evaluating how the company has historically treated policyholders over the years. A carrier with a strong track record of fair renewals over decades matters more than a flashy first-year rate.
Annuities are long-term tools, so it’s important to understand how and when you can access the money inside them. Most contracts include a surrender period, which is a defined number of years during which early withdrawals may trigger penalties. This structure helps insurance companies support the guarantees built into the contract, but it also means the funds should not be viewed as readily accessible cash.
Surrender schedules typically decline over time. For example, a 10-year schedule might begin with a 10 percent penalty in the first year, then decrease by one percent each year until it reaches zero. Many contracts include a free-withdrawal allowance, commonly up to 10 percent of the account value each year, even during the surrender period. Some also offer loan provisions that let you borrow against the annuity value with interest.
From a stewardship perspective, this is why an annuity should never be your only source of liquidity. It works best as one piece of a broader plan, providing stability, income, or protection while other assets remain available for near-term needs. Keeping a thoughtful balance between guaranteed tools and flexible resources supports healthy cashflow and ensures that your long-term strategy remains intact, even when life requires adaptation.
Annuities offer several ways to create income, each with a different balance of flexibility and guarantees. Lifetime income provides payments for as long as you live, protecting against longevity risk. Joint lifetime income continues payments for as long as either spouse is alive.
Period certain income guarantees payments for a set number of years, whether you live or not.
Systematic withdrawals let you take income at your own pace without giving up access to the remaining balance. Annuitization converts your full value into guaranteed payments but usually removes future flexibility, which is why it’s less commonly chosen today. Most people now use income riders, which offer lifetime guarantees while still allowing access to funds.
When you Think in Decades™, the right income structure is the one that supports long-term stability and aligns with the future you’re building.
An annuity is only as strong as the company standing behind its guarantees. Because these tools are designed for long-term planning, the insurer’s financial strength is one of the most important considerations. Independent agencies such as AM Best, Moody’s, and Standard & Poor’s evaluate an insurance company’s ability to meet its obligations, offering an objective view of its stability.
Beyond ratings, look for signs of financial discipline: strong reserves, consistent capital levels, and a history of treating policyholders fairly. These qualities matter just as much as the product’s features, because the true value of any guarantee depends on the company’s ability, and willingness, to honor it through all market environments.
The guidance you receive matters just as much as the product itself. Look for an advisor who takes a planning-first approach and can evaluate annuities alongside all your investment options, not in isolation. Advisors who hold broader licenses and experience across multiple areas of wealth management are often better positioned to offer objective recommendations grounded in your long-term goals, not in the product alone.
Taxes play an important role in how an annuity fits within your overall plan. Annuities can offer meaningful benefits, but they also come with limitations, so it’s important to understand both. They should be viewed as tools for tax management, not tax avoidance, and they work best when integrated into a broader strategy that considers all your income sources and long-term goals.
Gains inside an annuity grow tax-deferred, and withdrawals are taxed as ordinary income. If funds are taken before age 59½, a 10 percent federal penalty may also apply. Inherited annuities have their own IRS rules, which differ for spouses and non-spouse beneficiaries. Immediate annuities include an exclusion ratio, meaning part of each payment may be treated as a return of principal and not taxed.
The key is understanding how an annuity’s tax treatment interacts with the rest of your financial picture. When used thoughtfully, it can support long-term planning with clarity and intention.
When you Think in Decades™, annuities can play a strategic role within a broader financial plan. They can provide an income floor that reduces risk, which may allow the rest of your portfolio to stay invested for long-term growth. They can offer income stability in retirement, easing the stress of market volatility when you’re relying on your portfolio for living expenses. They also support longevity planning by transferring the risk of outliving your assets to an insurance company.
Because annuity guarantees are backed by insurer reserves rather than market performance, they may add diversification outside traditional investments. They can also help reduce sequence-of-returns risk by supplying income during market downturns, giving your invested assets time to recover. For many people, these guarantees create a baseline of security that supports both current needs and future legacy goals.
The right annuity, used thoughtfully, can bring clarity and confidence. The wrong one can create confusion. The difference lies in strategy and alignment with your long-term values, not in product features or sales language.
Questions to Ask Before Purchasing an Annuity:
What problem is this solving? If you can’t articulate the specific need this annuity addresses in your plan, reconsider.
What are all the fees? Get a complete breakdown, not just the highlighted features.
What can change each year? Understand which elements are guaranteed and which can be adjusted.
What happens if I need liquidity? Know your access to funds and the costs of early withdrawal.
What guarantees are contractual versus non-guaranteed? Read the fine print. Marketing materials emphasize what could happen. Contracts spell out what must happen.
What is the insurer’s financial strength? Check independent ratings and the company’s history.
What are the credentials of the individual recommending the annuity? Make sure they are credentialed beyond only selling insurance products or relying on commissions from the annuity sale.
If anyone pressuring you to purchase can’t or won’t answer these questions clearly, that’s your answer.
At Serae Wealth, clarity comes first. We help clients understand the moving parts of complex financial tools so they can make decisions that support the lives they want to build today and the legacies they hope to leave tomorrow.
Annuities are not for everyone. For the right person, in the right situation, with the right structure and a strong company behind it, they can be valuable tools for creating long-term stability, financial security, and peace of mind.
This commentary reflects the personal opinions, viewpoints and analyses of the author, Serae Wealth. It does not necessarily reflect the views of Foundations Investment Advisors, LLC (“Foundations”) and is provided for educational purposes only and the contents are solely maintained by and the responsibility of the applicable 3rd party. The 3rd party content is subject to change at any time without notice, and does not represent an express or implied opinion or endorsement of any specific investment opportunity, investment strategy or planning strategy. Foundations in no way deems reliable any statistical data or information obtained from or prepared by third party sources in this commentary, nor does Foundations guarantee its accuracy or completeness. No legal or tax advice is provided or intended.
Any comments regarding safe and secure investments and/or guaranteed income streams refer only to fixed insurance products overseen by state insurance regulators and not any investment advisory products. Rates and guarantees provided by insurance products and annuities are subject to the financial strength of the issuing insurance company; not guaranteed by any bank or the FDIC.