A deferred annuity is an insurance contract designed to accumulate money for future income. Unlike an immediate annuity, it does not typically begin making income payments soon after purchase.
But how does it work, and what are its benefits?
Understanding the different types, tax treatment, fees, withdrawal rules, and risks can help you decide whether an annuity fits your long-term retirement goals.
What Is a Deferred Annuity?
A deferred annuity is an insurance contract designed to accumulate funds before income payments begin. It can be funded through one or more premiums. During the accumulation period, the funds may earn interest or investment returns depending on the type of contract.
An immediate annuity generally begins income payments shortly after purchase, while a deferred annuity delays income payments until a future date. Both deferred and immediate annuities can have different contract structures, including fixed and variable options.
How Does a Deferred Annuity Work?
The process is typically simple:
- You contribute money: You pay a single amount or a set of payments.
- The money grows: The rate of growth depends on the type of contract, whether fixed or variable. It can also be indexable.
- You decide when the income will begin: Depending on the contract, you may be able to choose when to start receiving income or make withdrawals, subject to applicable terms and restrictions.
- You receive income later: Once the income phase begins, payments may continue for a specified period or for your lifetime, depending on the contract and payout option selected.
For instance, a person who is 50 years old may buy an annuity now, but plans to start receiving retirement benefits when they reach 65.
What Are The Types of Deferred Annuities?
Some common choices are:
- Fixed annuity: Offers an interest rate that is guaranteed for a set period of time and guarantees under contract subject to the ability of the insurer to pay.
- Variable annuities: Allows you to invest in a variety of investment options, meaning that the value of the annuity can fluctuate depending on market performance.
- Indexed annuity: Annuities that pay interest based on a formula that is linked to an index but subject to the contract’s terms caps, participation rates and other limitations.
What Are The Benefits of a Deferred Annuity?
Benefits could include:
- Tax-deferred Growth: Earnings generally are not taxed annually while they remain inside the annuity. Taxes may apply when taxable amounts are distributed, depending on the contract and account type.
- Future Income: A contract for future income could be converted into retirement benefits.
- Flexible Funding: Some contracts are funded with a single premium, while others allow additional contributions.
- Different risk Choices: Variable, fixed, and index-based structures offer various strategies for growth and security.
What Are the Risks and Costs of a Deferred Annuity?
A deferred annuity isn’t necessarily the best option for all investors. They can be a bit complicated and prices can be wildly different.
Before purchasing, make sure to check for:
- Charges for surrender and periods of surrender
- Investment-related or administrative fees
- Costs for riders with optional charges
- Restrictions on withdrawals
- Inflation risk
- Financial strength of the insurer
- Market risk for variable contracts
FINRA notes that annuities can be complex and expensive, with some contracts charging surrender fees and other costs. Tax rules also matter. Under U.S. federal rules, nonqualified annuity distributions before age 59½ may generally face an additional 10% tax unless an exception applies.
Deferred Annuity vs Immediate Annuity:
Understanding deferred vs immediate annuity options begins with a question: when do you require the income?
| Feature | Deferred Annuity | Immediate Annuity |
| Timing of income | Later | Usually, it is within a few days after the purchase |
| The main goal | Future income and accumulation | Savings can be converted into income |
| Growth phase | Yes | No or limited prior to payment |
| Common use | Future retirement planning | Current retirement source of income |
What Is a Tax-Deferred Annuity?
When people ask about a tax-deferred annuity it is usually an annuity in which taxes on earnings are delayed until funds are withdrawn. With a tax-deferred annuity, earnings generally are not taxed each year while they remain inside the contract. Taxes may apply when taxable amounts are distributed.
The tax treatment of an annuity depends on whether it is qualified or nonqualified, how it was funded, and how distributions are taken. Make sure to read the contract and seek tax-related advice from a professional prior to making an investment decision.
Deferred Income Annuity vs. Deferred Annuity
A deferred income annuity is a type of annuity designed to provide guaranteed income beginning at a future date. It can be useful for people who want to establish a future income stream for a specific stage of retirement.
A deferred annuity, more broadly, refers to an annuity in which income payments are delayed until a future date. Depending on the contract, it may be fixed, variable, or indexed and may provide different accumulation and income features.
Conclusion
A deferred annuity may be right for you if you want to accumulate funds for retirement on a tax-deferred basis or have income options in retirement. Still, it is essential to remember the surrender charges, inflation, investment risks, and the insurance company’s reliability.
Therefore, compare different options, study the contract terms and conditions, know when you can withdraw your money without additional charges, and consult a financial expert or tax adviser.
Frequently Asked Questions
Is a deferred annuity good for retirement?
A deferred annuity can be a retirement option for people who want to accumulate money for future income and may benefit from tax-deferred growth. However, it may not be appropriate for someone who needs easy access to their money.
How does a deferred annuity work?
You deposit money, let it build up under the rules of the contract and then receive annuity or withdrawal payments. The exact amount of growth and the income characteristics depend on the kind of annuity.
What is the difference between immediate annuity vs deferred annuity?
An immediate annuity typically starts paying out shortly after purchase, whereas deferred annuities delay payments until a future date.
Are tax deferred annuities tax-free?
No. Tax deferral typically means that taxes are delayed, not eliminated. Taxable distributions can be subject to income tax based on the applicable rules.
Can I withdraw money from a deferred annuity?
In most cases, yes, however, the contract may also impose restrictions on withdrawals or surrender fees. Early withdrawals that are taxable could cause an extra federal tax under certain circumstances.
What is a fixed income annuity?
It typically refers to an annuity which is designed to offer steady income with specific contract conditions. The precise guarantee is contingent on the insurance company issuing it and the contract.
What is a single premium deferred annuity?
It is a contract that is funded predominantly by a one-time premium and withdrawals or income delayed until a later date.
Can a deferred annuity lose money?
Yes, depending on the type of contract. Fixed annuities may provide contractual guarantees, while variable annuities can lose value because their underlying investments fluctuate with market performance. Indexed annuities also have specific risks and limitations outlined in the contract.
What should I compare before buying one?
Compare the cost of fees, surrender times and crediting or interest methods and investment options, as well as income guarantees, withdrawal options, death benefits, as well as the strength of the insurance company’s financials.
Should I choose an annuity or another retirement investment?
The decision is based on your income requirements and the time frame, your liquidity needs as well as your tax situation and the level of risk you are willing to take. Compare options prior to making an investment that will last for a long time.
