How a fixed annuity actually works

By Charles Mungovan, Founder, licensed insurance producer · Published 2026-08-14 · Last reviewed 2026-08-14

The basic mechanics

A fixed annuity is a contract between an owner and an insurance company. The owner pays a premium, and the insurer credits interest under the terms of the contract for a defined period — commonly three, five, seven, or ten years.

During that period the contract value is not directly exposed to market movement. Guarantees apply only as described in the contract and depend on the issuing insurer’s claims-paying ability.

Guarantees apply only as described in the issued contract and depend on the claims-paying ability of the issuing insurer. Annuities are not bank deposits, are not FDIC or NCUA insured, and are not guaranteed by any federal government agency.

What “guaranteed” refers to

In an annuity, a guarantee is a contractual promise from the insurance company. It is not a government guarantee, and annuities are not FDIC-insured. Financial-strength ratings from agencies such as AM Best are one input for evaluating an insurer, but a rating is an opinion as of a stated date and does not guarantee performance or the payment of claims.

The rate

The applicable rate is established under the issuing carrier’s contract and issue process and may change before the contract is issued. A quote or illustration is not the same as an issued contractual guarantee. Confirm any rate-lock rules and the applicable issue terms with the insurer.

Surrender charges and market value adjustments

In exchange for a stated rate, the contract limits how much can be withdrawn without a charge. Free-withdrawal provisions vary by contract, year, state, and carrier. Withdrawals above the free amount can trigger a surrender charge, and some contracts also apply a market value adjustment that can increase or decrease the amount received.

Some contracts include waivers — for example for confinement or terminal illness — but availability and conditions vary by contract and by state.

Taxes

Interest generally accumulates tax-deferred inside a non-qualified annuity and is taxed as ordinary income when withdrawn. Withdrawals before age 59½ may be subject to an additional 10% federal tax. Tax deferral is not tax elimination. Consult a tax professional about your situation.

When a fixed annuity tends to be discussed

• Money that can stay in place for the length of the surrender period.
• A preference for a stated rate over market participation.
• An understanding that liquidity is limited and that the guarantee depends on the insurer.

It is not designed for emergency funds or for money that may be needed on short notice.

Educational information only. This page is not individualized insurance, investment, tax, legal, or accounting advice, and it is not a recommendation to buy or replace any product.

Sources

• NAIC — Buyer’s Guide for Deferred Annuities
• Investor.gov — Annuities
• New York DFS — Immediate, deferred and guaranteed-rate annuities

Keep reading

• Surrender period
• Fixed annuities