What's the Average Rate of Return for an Annuity?

If you’re thinking about purchasing an annuity, you might be curious about the kind of returns you can expect. The rate of return plays a key role in how your portfolio grows and how much income you’ll have in retirement. It’s also important to keep in mind that fees can reduce your overall earnings. Knowing how to calculate the average return on your annuity can help you make more informed decisions.

A financial advisor can also guide you through the process and help you evaluate all the key factors when considering an annuity.

Average Rate of Return for an Annuity

There are three basic types of annuities and each one has different rates of return for the annuity owner. The average rate of return you receive depends on the amount of risk you are willing to take with your account.

Fixed Annuity

Fixed annuities are similar to bank certificates of deposit (CDs) because they offer a guaranteed rate of return. These are generally the safest annuity investment and are backed by the financial strength of the insurance company. While you will not receive outsized returns, you don’t have to worry about your account value dropping either.

Many investors choose fixed annuities to balance the risks associated with their stock portfolio. The guaranteed income from a fixed annuity gives investors peace of mind through the ups and downs of the stock market.

The average return of a fixed annuity varies based on the term of your annuity. In general, though, the longer your contract’s term is, the better the rate you’ll receive. Remember that any fees you encounter will shrink your returns, though.

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Our investment calculator estimates how your balance could grow over time based on a fixed return.

Enter an initial amount, choose a recurring contribution schedule and see how consistent investing influences both your pace of growth and your ending balance. The calculator compounds the assumed returns, meaning estimated earnings are reinvested and may generate additional estimated earnings over time.

This calculator illustrates hypothetical outcomes over periods of five years or longer because the modeled effects of returns, tax savings and advisor fees are intended to represent a multiyear scenario.

To further customize your estimate with additional personal inputs, please explore our full Financial Advisor Value Calculator.

Assumptions

Rate of Return: For your main investment projection, we assume your rate of return compounds based on the frequency at which you contribute. The with-advisor projection applies returns, fees and tax savings on an annual basis.

Contributions: We assume each contribution occurs at the end of the selected contribution period.

Advisor Return Premium: For the with-advisor projection, an advisor is assumed to yield an additional annual average of 1.0495% of a client’s income in tax savings during their career and a 2.47% premium in annual returns, whether through investment allocations and performance, general guidance and coaching, or other more custom areas of financial benefit.

Advisor Fees: We assume annual advisor fees of 1% for a current investment value less than $1 million, and 0.75% for a current investment value of $1 million or above.

This calculation also uses assumptions and equations detailed in SmartAsset’s whitepaper, “The Value of a Financial Advisor: What’s It Really Worth?”.

This hypothetical example is for illustrative purposes only and does not represent an actual client or specific security. Actual results will vary. Past performance is not a guarantee of future results.

SmartAsset does not provide legal, tax, accounting, financial or investment advice. SmartAsset may refer users to third-party advisers registered or chartered as fiduciaries with a U.S. regulatory body. Articles, opinions and tools are provided for general informational purposes only and are not intended to provide individualized advice or recommendations. Consult an appropriate legal, tax, accounting or financial professional regarding your individual circumstances.

This material does not constitute an offer to buy or sell any security or other investment. All investing involves risk, including the possible loss of principal. Working with an adviser generally involves fees and expenses, which will reduce investment returns. There is no guarantee that working with an adviser will improve investment performance or produce any particular financial outcome. A fiduciary duty does not eliminate all potential conflicts of interest.

Indexes are unmanaged and do not reflect the deduction of transaction costs, management fees or other expenses. It is not possible to invest directly in an index. Exposure to an asset class represented by an index may be available through investable products that seek to track or otherwise provide exposure to that index.

Certain information, including prices, quotations and statistics, was obtained from sources believed to be reliable, but SmartAsset does not guarantee its accuracy or completeness.

Variable Annuity

A variable annuity invests in separate accounts that are similar to mutual funds. These separate accounts can invest in stocks, bonds and other assets that can fluctuate in value. Variable annuities offer a selection of investments that represent different sectors of the market. The options are typically a mix of stocks and bonds that are based in both domestic and foreign markets.

Investors choose variable annuities when they are willing to accept more risk for the opportunity to grow their balance faster. While there is upside potential, there are no guarantees of what the future value of the account will be. This uncertainty means that the investor does not know how much retirement income they can expect from their variable annuity.

Again, the average variable annuity rate of return depends on the investment options that you select. Variable annuities usually feature many choices, but returns are often similar to popular ETFs and index funds (8% to 10% annually, on average). Your contract fees and investment expense ratios will eat into these returns, though.

Indexed Annuity

A man holding a notebook labeled "annuity."

Equity indexed annuities were created to give investors the upside of the stock market with the guarantees of a fixed annuity. Their returns are tied to a specific index, like the S&P 500. These annuities participate in the stock market returns, while generally guaranteeing a minimum rate of return when stocks fall. Sometimes this minimum rate of return is zero. While this means that you don’t earn anything that year, it also means that you won’t lose money.

The downside of equity-indexed annuities is that you only participate in a portion of the stock market’s growth. Additionally, there’s usually a cap on your maximum return. This means that no matter how much the stock market increases, your return will not go higher than your cap. For example, let’s say that the stock market increases 20% and you have 75% participation and a 12% cap. Your participation limits your return to 15%. Yet, the 12% cap means that your maximum return can only be 12%.

The average equity-indexed annuity rate of return varies based on the stock market’s performance, your participation rate and your cap. Again, these returns are entirely dependent on the specifics of your annuity contract.

How to Calculate Your Rate of Return

There are two rates of return for your annuity. The total rate of return tells you how much your annuity contribution has increased, while the compound annual growth rate is the average amount it grew each year.

Total Rate of Return

To calculate the total rate of return of your annuity, follow this simple formula. Take the annuity’s current value minus your contribution, then divide that total by your contribution. Multiply the result by 100 to get a percentage value.

The total rate of return formula is (Current value – Contribution) / Contribution x 100. For example, ($500,000 – $400,000) / $400,000 x 100 = 25%.

While the total rate of return provides the return for the entire time that you hold investments, it does not provide the average annual rate of return for your investment. To get that number, you would need to use the compound annual growth rate formula.

Compound Annual Growth Rate

For your annuity’s compound annual growth rate (CAGR), here is the formula:

(Ending balance / Starting balance) ^ (1 / Years) – 1 = CAGR

You divide the ending balance by the starting balance and raise the result to the power of one divided by the number of years invested. Then subtract one.

If it took four years for your contribution to grow from $400,000 to $500,000, the calculation would be:

($500,000 / $400,000) ^ (1 / 4) – 1 = 5.7%

In other words, you would need an annualized growth rate of about 5.7% over four years to grow $400,000 to $500,000.

Tax Treatment of Annuity Returns

Taxes on annuity growth are generally postponed while earnings remain inside the contract. The tax consequences typically arise when money is distributed, with the treatment depending in part on how the annuity was funded.

With a non-qualified annuity purchased using after-tax dollars, distributions taken before the annuity starting date are generally treated as coming from investment gains before principal for federal tax purposes. Those earnings are taxed at ordinary income rates. After the gains have been distributed, amounts attributable to the owner’s original investment generally are not taxed a second time.

That differs from the treatment of investments held in a taxable brokerage account. Long-term capital gains may be taxed federally at 0%, 15% or 20%, depending on taxable income, whereas taxable annuity gains generally fall under ordinary income tax rates. Two investments producing the same pretax return could therefore generate different after-tax results.

Age can also affect the tax cost of taking money from an annuity. If a taxable distribution is made before age 59½, the taxable portion may face an additional 10% federal tax unless an exception applies. The insurer may also impose surrender charges depending on the contract terms and when the withdrawal occurs.

Different rules apply when an annuity is held inside a tax-deferred retirement account. Distributions from an annuity owned through a traditional IRA or another pre-tax retirement arrangement are generally taxed as ordinary income, except for any portion attributable to after-tax basis. Because the retirement account already provides tax deferral, placing an annuity inside it does not create another layer of tax-deferred treatment.

For example, suppose a non-qualified variable annuity purchased for $400,000 grows to $500,000. If you withdraw $100,000 before the annuity starting date, that amount would generally be treated as taxable earnings first. At an assumed 24% federal rate, the federal income tax would be $24,000 ($100,000 × 0.24), leaving $76,000 after federal income tax ($100,000 − $24,000). This simplified example does not account for state taxes, penalties, fees or other factors that could change the result.

Taxes can therefore change how much of an annuity’s return you ultimately keep. When comparing an annuity with other investments, consider not only the stated return but also how distributions may be taxed based on the account structure, your circumstances and the timing of withdrawals.

Questions to Ask Before Buying an Annuity

Before you commit to purchasing an annuity, it’s a good idea to understand exactly what you’re getting. Asking the right questions can help you evaluate whether an annuity fits your needs and avoid surprises down the road. Below are some key questions to discuss with your advisor or insurance company before signing a contract.

What Are the Total Fees?

Annuities often come with various charges, such as administrative fees, mortality and expense (M&E) fees, investment management fees (for variable annuities) and optional rider costs. Understanding all the fees involved can help you assess how much they may reduce your returns over time.

What Is the Surrender Period?

Most annuities have a surrender period, or a set number of years during which you’ll pay a penalty if you withdraw funds early. Be sure you know how long your money will be locked up and what the surrender charges are.

How Is My Income Payout Calculated?

Find out how your annuity converts into income, including whether payouts are fixed or variable, and how long they last. Some annuities offer lifetime income guarantees, while others pay for a specific period.

Is the Issuing Insurance Company Financially Strong?

Your annuity is only as secure as the company behind it. Check the financial strength ratings of the insurer through agencies like AM Best, Moody’s or Standard & Poor’s to ensure it can meet its future obligations.

Do you have enough money saved for retirement at your current stage? Calculate where you stand right now:

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Bottom Line

A dollar sign in front of a stock chart.

An annuity’s returns and the income it can provide in retirement depend on the type you choose, how long you invest and the performance of the underlying investments. Many people choose fixed annuities for guaranteed returns that can balance some of the risks in their stock portfolios.

“It’s best practice to consult a fiduciary financial advisor when considering an annuity as part of your retirement plan. They can help you identify the best option for your needs without any bias, take into account your total financial picture, timeline and risk tolerance and thoroughly explain the tradeoffs of purchasing an annuity,” said Tanza Loudenback, CFP®.

Tanza Loudenback, CFP® provided the quote used in this article. Please note that Tanza is not a participant in SmartAsset AMP, is not an employee of SmartAsset and has been compensated. The opinion voiced in the quote is for general information only and is not intended to provide specific advice or recommendations.

Tips for Annuity Buyers

Choosing which type of annuity is best for your situation can be a challenge. A financial advisor can describe the pros and cons of each and present solutions to match your needs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Our retirement calculator will help you determine how much income you’ll need for retirement based on your assets, sources of income and expected expenses. Knowing your retirement income needs can help you decide if an annuity is right for you.