It's been a tough stretch financially for many Americans. Inflation has eased from its peak, but the cost of everything from groceries to insurance remains elevated. At the same time, recent bouts of stock market volatility have left even seasoned investors feeling uneasy. As a result, the idea of locking in guaranteed retirement income, which can be done by investing in an annuity, has become more appealing for people nearing retirement or those already in it. 

Today's elevated interest rate environment has also made some annuity products more attractive than they were just a few years ago. Fixed annuities, in particular, may be offering stronger payouts right now, and that's caught the eye of investors who are looking for stability. But while the guaranteed income aspect sounds great on paper, many people wonder about the tradeoffs. Chief among those concerns is the idea of losing your principal when you buy an annuity.

The fear of losing the initial investment has prevented many people from considering annuities as part of their retirement strategy, despite the potential benefits they offer. But is losing your principal really a risk you take when investing in an annuity? 

.

Do you lose your principal when you invest in an annuity?

In general, you don't automatically lose your principal when you invest in an annuity. But depending on the kind of annuity you buy, your money may be more or less protected.

With , your principal is typically safe. You hand over a lump sum to the insurance company, and in return, they guarantee both the return of your initial investment (after a set period) and interest payments at a locked-in rate. These are straightforward, low-risk products that are ideal if you want predictable income and peace of mind.

works a little differently. Your return is tied to the performance of a market index like the S&P 500, but you're still protected against losses. Even if the market dips, your principal won't. However, your upside is also capped, so while you won't lose money, you may not earn as much as someone directly invested in stocks during a bull market.

The real risk to your principal comes into play with . These annuities allow you to invest your money into sub-accounts that function similarly to mutual funds. If those investments perform poorly, you could lose part of your original investment. Some insurers offer riders that protect your principal (for a fee), but without those protections, your money is subject to the whims of the market.

.

Factors that could reduce your principal  

Even if your annuity type offers principal protection, other factors could still reduce what you walk away with, especially if you need to access your funds early.

. Most annuities come with surrender periods, which are a set number of years during which you'll pay a penalty if you withdraw more than the allowed free amount. These surrender charges generally start at about 7% of the withdrawal and decrease over time, but they're an important consideration. If you think you may need quick access to your full principal, an annuity might not be the best fit.

There are also tax implications to keep in mind. Annuities grow tax-deferred, which is great, but if you withdraw before age 59½, you'll likely pay a 10% early withdrawal penalty on the earnings portion of the annuity, plus ordinary income tax. These costs don't eat into your principal directly, but they do reduce the value of what you take home if you tap into your annuity too soon.

You should be aware of fees and optional riders, too. Riders can provide valuable benefits, like guaranteed lifetime income, long-term care coverage or death benefits, but they come at a cost. Those fees can eat into your growth over time, especially with variable annuities.

The bottom line

Annuities can offer principal protection, but it's not guaranteed across the board. Fixed and fixed indexed annuities typically shield your original investment, while variable annuities come with more risk. And even with principal-safe products, things like surrender charges, early withdrawal penalties and rider fees can reduce your net return if you're not careful.

If you're considering an annuity, the most important step is understanding exactly what you're buying. While an annuity can be a powerful tool for securing retirement income, it only makes sense to consider if it fits your broader financial picture. So, be sure to read the fine print and ask questions before locking in, like whether your principal is guaranteed, how long your money will be tied up, what the potential earnings look like and what fees apply.