Yes, annuities do earn interest, though not all of them in the same way. A fixed annuity earns a guaranteed interest rate set by the insurance company. A fixed indexed annuity earns interest tied to the performance of a market index, with limits built in. A variable annuity does not pay interest at all; it generates investment returns that rise or fall with the sub-accounts you choose. Across all three, earnings grow tax-deferred until you take money out.
Fixed Annuities: A Guaranteed Rate
A fixed annuity works much like a bank certificate of deposit. The insurer guarantees a specific interest 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 do not bear the investment risk.
As of early 2026, top rates on multi-year guaranteed annuities run from roughly 4% for a one-year term to over 6% for five- to ten-year terms, varying by insurer and financial strength rating. Many contracts add a first-year bonus of 1% to 3% on top of the base rate, then revert to a renewal rate the insurer resets periodically.
Every fixed annuity also carries a guaranteed minimum rate, usually between 1% and 3%. That floor is the lowest rate the insurer can ever credit, regardless of what happens in the broader economy. The combination of a contractual floor and the insurer absorbing investment risk makes fixed annuities one of the more conservative ways to grow retirement savings.
Fixed Indexed Annuities: Interest Tied to a Market Index
A fixed indexed annuity links your interest credits to an outside index, such as the S&P 500, without actually investing your money in the stock market. If the index drops during a crediting period, your account earns zero for that period rather than taking a loss. Your principal does not go backward because of market declines.
Three levers decide how much of the index’s gain actually reaches your account:
- Participation rate — the percentage of the index gain that counts toward your credit. If the index rises 10% and your participation rate is 80%, you receive 8%.
- Cap rate — a ceiling on interest in a single crediting period. If your cap is 5% and the index rises 12%, your credit stops at 5%.
- Spread or margin — a flat percentage subtracted from the index gain. With a 2% spread and a 10% index gain, you receive 8%.
Not every contract uses all three. Some apply only a participation rate; others combine a cap with a spread. The insurer can reset participation rates and caps at the end of each crediting period, but the contract guarantees minimum levels — for example, a minimum participation rate of 5% and a minimum cap of 3% for the life of the contract. In practice, that means your worst year with a rising index is still a small positive credit, and your worst year overall is zero.
Variable Annuities: Investment Returns, Not Interest
Variable annuities do not pay a set interest rate. You put money into sub-accounts that behave like mutual funds — stock portfolios, bond funds, money market instruments, or a mix.1U.S. Securities and Exchange Commission. Investor Tips – Variable Annuities Values move daily with the market. You carry the investment risk, so the account can grow faster than a fixed or indexed annuity in a strong market and can also lose value in a downturn.
Several layers of fees cut into whatever the sub-accounts produce:
- A mortality and expense risk charge of roughly 1.25% of account value per year, paid to the insurer for the guarantees built into the contract.2U.S. Securities and Exchange Commission. Variable Annuities – What You Should Know
- Administrative fees around 0.15% per year, or a flat $25 to $30 annually, for record-keeping.2U.S. Securities and Exchange Commission. Variable Annuities – What You Should Know
- Underlying fund expenses charged inside each sub-account, just like a mutual fund.
Total annual costs often land between about 1.5% and over 2% of account value. Fees compound against you in the same way returns compound for you, so reading the fee schedule matters as much as reading the investment menu.
How Credited Interest Compounds
Once interest is credited to a fixed or indexed annuity, it becomes part of your principal and earns interest itself in future periods. The timing of credits depends on the contract: fixed annuities may credit daily, monthly, or annually, while indexed annuities usually credit at the end of each crediting period, often one year.
Credited interest in a fixed or indexed contract is locked in. A later index drop or a weak year for the insurer’s investments cannot claw it back. During the accumulation phase, the account value moves up or stays flat; it does not fall because of market losses. Over 15 to 20 years, that ratchet effect can add up even when individual year credits are modest.
Variable annuities compound differently. Gains and losses show up in real time as the price of the sub-account units changes each business day, and there is no locked-in floor to protect prior gains.
When You Owe Tax on the Interest You Earn
Interest and investment gains inside an annuity are tax-deferred. You owe no federal income tax on them while the money stays in the contract.3Internal Revenue Service. Publication 575 – Pension and Annuity Income The full balance keeps compounding instead of being trimmed each year by tax on dividends or capital gains.
Tax arrives when you withdraw. For a non-qualified annuity bought with after-tax dollars, withdrawals come out of earnings first and principal last.4Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities, Certain Proceeds of Endowment and Life Insurance Contracts If you put in $100,000 and the account grew to $140,000, the first $40,000 you take out is fully taxable as ordinary income. Only after the earnings are exhausted does the rest come back as a tax-free return of your original deposit.3Internal Revenue Service. Publication 575 – Pension and Annuity Income
Withdrawals before age 59½ add a 10% federal penalty on the taxable portion, with limited exceptions for death, disability, and certain structured payment schedules.4Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities, Certain Proceeds of Endowment and Life Insurance Contracts5Internal Revenue Service. Topic No. 558 – Additional Tax on Early Distributions From Retirement Plans Other Than IRAs Taxable distributions can also count toward net investment income, which may trigger an additional 3.8% surtax if your modified adjusted gross income is high enough.
Surrender Charges Limit Early Access
Annuities are built as long-term contracts, so insurers charge a surrender fee if you pull out more than a set amount during the early years. A typical surrender period runs six to eight years, sometimes ten.6U.S. Securities and Exchange Commission. How Fees and Expenses Affect Your Investment Portfolio The charge is highest in year one and steps down each year, often from 6% to zero over seven years.
Most contracts allow a free withdrawal each year, commonly 10% of the account value, without a surrender charge. Anything beyond that is charged for the rest of the contract year. These charges stack on top of the 10% federal tax penalty if you are also under 59½, so an early exit can cost you twice.