Yes, annuities do earn interest, but how they earn it depends on the type. A fixed annuity pays a guaranteed interest rate set by the insurance company. A fixed indexed annuity credits interest tied to a market benchmark like the S&P 500, subject to built-in limits. A variable annuity doesn’t pay a set interest rate at all — its value rises or falls with the sub-accounts you choose. In all three, earnings grow tax-deferred until you take money out.
Fixed Annuity Interest Rates
A fixed annuity works much like a bank certificate of deposit. The insurer guarantees a specific rate for a set period, commonly one to ten years, and invests its own general account (typically high-grade corporate bonds and government debt) to back that promise. You don’t bear the investment risk; the insurer does.
As of early 2026, top rates on multi-year guaranteed annuities range from roughly 4% for a one-year term to over 6% for terms of five to ten years, though rates vary by insurer and financial strength rating. Many contracts add a first-year bonus of 1% to 3% on top of the base rate for the initial twelve months, after which the rate reverts to a renewal rate the insurer sets periodically.
Every fixed contract also carries a guaranteed minimum rate — the floor below which the credited rate can never drop, regardless of market conditions. That floor typically sits between 1% and 3%, depending on the contract and when it was issued.
How Fixed Indexed Annuities Calculate Interest
A fixed indexed annuity ties your interest credits to an external market index without directly investing your money in stocks. If the index loses value during a crediting period, your account earns zero rather than taking a loss. If the index rises, the insurer applies a formula with built-in limits to decide how much of that gain reaches your account.
Three levers control the credit:
- Participation rate: the percentage of the index’s gain that counts. If the index rises 10% and your participation rate is 80%, you receive 8%.
- Cap rate: a ceiling on the interest you can earn in a single crediting period. A 5% cap means a 12% index gain still credits only 5%.
- Spread or margin: a flat percentage subtracted from the index gain before your credit is calculated. A 2% spread against a 10% index gain yields 8%.
Not every contract uses all three. Some apply only a participation rate; others combine a cap with a spread. The specific terms depend on the crediting strategy you select, and the insurer can adjust participation rates and caps at the end of each crediting period. The contract, however, guarantees minimums for both — a contract might guarantee, for instance, a minimum participation rate of 5% and a minimum cap of 3% for its life. Your worst-case year is a small positive credit when the index rises and zero when it falls.
How Variable Annuities Grow
Variable annuities do not pay a set interest rate. You invest in sub-accounts that function like mutual funds — stock portfolios, bond funds, money market instruments, or a mix.1U.S. Securities and Exchange Commission. Investor Tips – Variable Annuities Your account value changes daily. You bear the investment risk, so a strong market can outpace a fixed or indexed annuity, and a downturn can cut your balance.
Fees matter more here than in any other annuity type, because they compound against you just as returns compound for you:
- Mortality and expense risk charge: typically around 1.25% of account value per year, compensating the insurer for guarantees built into the contract.2U.S. Securities and Exchange Commission. Variable Annuities – What You Should Know
- Administrative fees: usually around 0.15% per year or a flat $25 to $30 annual fee, covering record-keeping.2U.S. Securities and Exchange Commission. Variable Annuities – What You Should Know
- Underlying fund expenses: each sub-account charges its own annual operating expenses, just like a mutual fund.
Add these together and total annual fees often land between roughly 1.5% and well over 2% of account value.
How Compounding and the Ratchet Lock In Growth
Once interest is credited, it becomes part of your principal and forms the base for future growth. Fixed annuities may credit interest daily, monthly, or annually. Indexed annuities typically credit at the end of each crediting period, often one year but sometimes longer. Variable annuities reflect gains and losses in real time as sub-account values change each business day.
In a fixed or indexed annuity, once a credit posts, it is locked in. Later index declines or weak insurer investment performance cannot claw it back. This ratchet feature means your account moves only up or flat during the accumulation phase, never down from market losses. Over 15 to 20 years, even modest annual credits can build meaningfully.
Taxes on Annuity Earnings
Earnings inside any annuity grow tax-deferred. You owe no federal income tax on interest or investment gains while the money stays in the contract.3Internal Revenue Service. Publication 575 – Pension and Annuity Income The full balance compounds without the annual tax drag you’d see in a taxable brokerage account.
Withdrawals follow an earnings-first rule for a non-qualified annuity (one purchased with after-tax dollars). Every dollar you take out is treated as coming from earnings first and from your original investment last.4Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities, Certain Proceeds of Endowment and Life Insurance Contracts If you deposited $100,000 and the contract grew to $140,000, the first $40,000 you withdraw is fully taxable as ordinary income. Only after all earnings come out does the rest emerge as a tax-free return of principal.3Internal Revenue Service. Publication 575 – Pension and Annuity Income
The 10% Early Withdrawal Penalty
Taking taxable money out before age 59½ triggers a 10% federal penalty on top of ordinary income tax.4Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities, Certain Proceeds of Endowment and Life Insurance Contracts Exceptions include withdrawals taken after the owner’s death, withdrawals due to disability, and distributions structured as a series of substantially equal periodic payments over your life expectancy.5Internal Revenue Service. Topic No. 558 – Additional Tax on Early Distributions From Retirement Plans Other Than IRAs
Net Investment Income Tax
Taxable distributions from a non-qualified annuity may also count toward net investment income, which can add a 3.8% surtax if your modified adjusted gross income exceeds certain thresholds. It’s easy to miss this when projecting after-tax returns.
Surrender Charges and Liquidity Limits
Annuities are long-term contracts, and insurers impose surrender charges if you pull out more than a specified amount during the early years. A typical surrender period runs six to eight years; some extend to ten.6U.S. Securities and Exchange Commission. How Fees and Expenses Affect Your Investment Portfolio The charge is highest in year one and declines each year until it disappears. A common schedule: 6% in year one, dropping one percentage point per year, reaching 0% in year seven.
Most contracts include a free withdrawal provision, often 10% of account value per year, without triggering a surrender charge. Anything above that threshold is charged for that contract year. These charges sit on top of any tax penalty for early withdrawal, so tapping an annuity before 59½ can mean paying both the insurer and the IRS.
What Beneficiaries Receive
If you die during the accumulation phase before annuity payments begin, your named beneficiary typically receives the full account value — your contributions plus all accumulated earnings. The earnings portion is taxable to the beneficiary as ordinary income; the return of your original after-tax contributions is not. A surviving spouse may have the option to continue the contract rather than take a lump sum, which preserves the tax-deferred status of the remaining earnings.