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- Updated: January 17, 2023
- 12 min read time
- This page features 10 Cited Research Articles
What Is a Deferred Annuity and How Does It Work?
When you purchase an annuity, if you decide to start receiving payments within a year, you have an immediate annuity. Should you decide to wait to collect payments, you have a deferred annuity.
Deferred annuities allow your principal to increase before you begin to receive the stream of payments. You can pursue a strategy combining the advantages of immediate and deferred annuities by getting a split-funded annuity.
According to the LIMRA Secure Retirement Institute, deferred annuities are forecast to have the largest growth rates amongst annuity types in the coming years.Pro TipDeferred annuities offer short-term solutions to people seeking to protect their savings.Source: LIMRA
Deferred annuities are also classified according to how you pay for them. You can make one payment or several. And if you make several payments, they can be structured in different ways.“Deferred annuities can be a great option when an investor has a significant amount of taxable money sitting in a brokerage account and is in a high tax bracket. Moving money to a deferred annuity will shelter that money from on-going taxation on their investment income.”
Example of a Deferred Annuity
A deferred annuity makes sense for people nearing retirement or for younger investors who have maxed out their retirement plans but still want to put money into tax-deferred retirement vehicles.
Typically, annuity buyers are in their 60s. They’ve accumulated a significant amount of retirement savings and can roll that money over into annuity products without triggering adverse tax events.
If you are a younger investor, a deferred annuity allows you to accumulate wealth as you work. Then, in retirement, you can achieve a guaranteed lifetime income stream.
However, a deferred annuity limits your ability to repurpose your retirement savings — and can be very difficult to reverse if you change your mind. You will have to wait for your annuity income, with a deferred annuity. If you need more near-term liquidity, , you may want to consider an immediate annuity .Interested in Buying an Annuity?Learn about the different types of annuities and find out which one is right for you.
What Are the Types of Deferred Annuities?
Deferred annuities come in a few different varieties, each with different features and benefits. The most common types of deferred annuities are single premium deferred annuities and flexible premium deferred annuities.
Single premium deferred annuities are purchased with one lump sum of money.
There are advantages and disadvantages with single premium deferred annuities. For example, a single premium deferred annuity might tie up more of your money than you ultimately could afford to put into it, which could wind up costing you a surrender fee.Single Premium Pros and ConsPros
- Guaranteed rate of return
- Principal protection
- Potential surrender charges
- Lack of capital for investments (opportunity cost)
A flexible premium annuity is a type of deferred annuity that is purchased with a series of payments. These payments can be scheduled as specific amounts — known as scheduled premium deferred annuities — or they can be adjustable. When the payments are adjustable, the vehicle is commonly referred to as a flexible premium deferred annuity.Flexible Premium Pros and ConsPros
- Less capital tied up
- More time to pay for the product best suited to you
- Rate of return not guaranteed
- Potential contribution limits
How Is a Deferred Annuity Different from Other Types of Annuities?
“A deferred annuity is an annuity that allows you to delay receiving payments until a later date,” said Linda Chavez, a licensed insurance agent. During the deferral period, which is known as the accumulation phase, the annuity contract earns interest and increases in value.
An immediate annuity is structured differently. This type of annuity contract does not have an accumulation phase. Immediate annuities undergo annuitization as soon as the contract is signed, which means the income payments can begin immediately. That said, many immediate annuity owners elect to initiate the payment stream up to a year after purchase.
Accumulation Phase of a Deferred Annuity
There are two phases to a deferred annuity: The accumulation phase and the payout phase.
During the accumulation phase, the annuity accumulates interest on a tax-deferred basis. During the payout phase, the annuity distributes income.
The accumulation phase works differently, depending on the annuity type.Accumulation Based on Type of Annuity
- Fixed deferred annuity
- If you have a contract for a fixed annuity, your financial investment will accrue interest at a guaranteed, fixed rate.
- Variable deferred annuity
- A variable annuity allows you to invest your premiums in mutual funds comprised of stocks, bonds and/or short-term money market instruments. Your rate of return depends on the performance of these investments
- Indexed deferred annuity
- An indexed annuities accrues interest based on the performance of a specified index, such as the S&P 500. This type of contract guarantees you will receive a minimum rate of return, regardless of how the referenced index performs. However, your upside performance is usually capped.
Regardless of the type of accumulation your deferred annuity uses, you don’t pay taxes on those earnings during the accumulation phase. Taxes are not due until you reach the payout phase. This is true for federal income taxes and any applicable state premium taxes.
Payout Options for a Deferred Annuity
Once annuitants reach the distribution phase of their contract, which typically begins when they reach the age of 59½, they can receive payouts from the annuity in one of three ways.Deferred Annuity Payout Options
- Lump sum
- In a lump-sum disbursement, an annuity is distributed as a one-time, taxable single payment.
- Systematic withdrawals
- When funds are dispersed via systematic withdrawal, the annuity can be withdrawn or disbursed through periodic taxable payments. Any remaining money continues to earn interest until the account has been depleted.
- Under an annuitization distribution plan, an annuitant receives monthly, quarterly or yearly payments for a designated amount of time, until the annuitant’s death or until the annuitant’s spouse dies.
If you die during the accumulation period, a deferred annuity includes a basic death benefit that pays some or all of the value of the annuity to your beneficiaries. If you die during the payout phase, your beneficiaries may not receive anything unless you have a specific provision in your annuity contract providing for your beneficiaries to be paid.
Pros and Cons of a Deferred Annuity
As with any investment, deferred annuities carry several benefits and risks.Pros:
- Tax-Deferred Investment
- Annuity owners do not pay taxes during the accumulation phase. Taxes apply once the distribution phase begins and the owner starts to receive payments.
- Guarantees Against Loss
- Most deferred annuity contracts have built-in guarantees against loss of principal and some offer guaranteed rates of return. However, loss of capital is possible with variable annuities.
- Lifetime Benefits
- Depending on how you structure your annuity, it’s possible to receive guaranteed income payments for life.
- Death Benefits
- Many deferred annuity contracts include a death benefit component. This ensures that any surviving heirs receive any remaining assets if you die before the end of the annuity contract.
- No Contribution Limits
- Unlike with IRAs and 401ks, the IRS places no limits on the principal amount you can contribute to a deferred annuity.
- Lack of Liquidity
- Generally, annuitants are unable to withdraw any money from their annuity during the contract’s first several years unless they pay a surrender charge for withdrawals. In addition, you’ll pay a penalty to the IRS for any withdrawal you make before you are at least 59 1/2.
- High Tax Rates on Earnings
- Because annuity contracts grow on a tax-deferred basis, the IRS taxes annuity earnings at the ordinary income rate, which may be higher than the capital gains rate applied to stocks, mutual funds and exchange traded funds.
- Additional Expenses
- Maintaining a deferred annuity contract can be expensive due to administrative fees, funding expenses, charges for special features and riders, and commissions.
Frequently Asked Questions About Deferred AnnuitiesHow soon do payments begin with a deferred annuity?Payments are usually deferred until the annuitant reaches retirement age. Your age when you purchase the annuity will affect how long it stays in the accumulation phase.What is a fixed deferred annuity and how is it different from other deferred annuities?A fixed deferred annuity earns interest based on a guaranteed fixed rate. This differs from indexed or variable annuities, which accrue interest based on the performance of indexes (in the case of indexed annuities) and underlying investments (in the case of a variable annuity).How are deferred annuities taxed?With a deferred annuity, you won’t owe any tax until you begin receiving payments from the annuity. You’ll only be taxed on the portion of the payment that is accumulated interest.How do interest earnings accumulate in a deferred annuity?A fixed annuity earns interest at a guaranteed rate, while the value of indexed and variable annuities is tied to market performance.Can you lose money in a deferred annuity?You can lose money if you withdraw funds from your deferred annuity before the payout phase begins. If you have a variable deferred annuity and the market performance is poor, you could lose some of the value of your annuity over time.How much money should I put in a deferred annuity?For a single-premium deferred annuity, your minimum investment could be as low as $25,000.Please seek the advice of a qualified professional before making financial decisions.Last Modified: January 17, 2023
10 Cited Research Articles
Annuity.org writers adhere to strict sourcing guidelines and use only credible sources of information, including authoritative financial publications, academic organizations, peer-reviewed journals, highly regarded nonprofit organizations, government reports, court records and interviews with qualified experts. You can read more about our commitment to accuracy, fairness and transparency in our editorial guidelines.
- Bishop, J. (2022, May 18). Can You Lose Money with an Annuity? Retrieved from https://due.com/blog/can-you-lose-money-with-an-annuity/
- Bloink, R. & Byrnes, W.H. (2017, February 17). Single Premium Deferred Annuities: One Size Does Not Fit All. Retrieved from https://www.thinkadvisor.com/2017/02/17/single-premium-deferred-annuities-one-size-does-no/
- Brooks, R. (2022, May 17). What Is a Deferred Annuity? Retrieved from https://money.usnews.com/money/retirement/401ks/articles/what-is-a-deferred-annuity
- Cotton, D. (2017, November 8). Income Annuities: Immediate And Deferred. Retrieved from https://seekingalpha.com/article/4122646-income-annuities-immediate-and-deferred
- Financial Web. (n.d.) Immediate and Deferred Annuities. Retrieved from https://www.finweb.com/insurance/immediate-and-deferred-annuities.html
- LIMRA. (2018, June 7). LIMRA Secure Retirement Institute Forecasts Total Annuity Sales to Improve Through 2019. Retrieved from https://www.limra.com/en/newsroom/industry-trends/2018/limra-secure-retirement-institute-forecasts-total-annuity-sales-to-improve-through-2019/
- National Association of Insurance Commissioners. (2013). Buyer’s Guide to: Fixed Deferred Annuities. Retrieved from https://content.naic.org/sites/default/files/publication-anb-lp-consumer-annuities-fixed.pdf
- South Carolina Department of Insurance. (n.d.). 10 Things You Should Know About Buying Fixed Deferred Annuities. Retrieved from https://www.doi.sc.gov/598/Buying-Fixed-Deferred-Annuities
- U.S. Securities and Exchange Commission. (n.d.). Deferred Annuity. Retrieved from https://www.investor.gov/introduction-investing/investing-basics/glossary/deferred-annuity
- Woman’s Life Insurance Society. (n.d.). Fixed Deferred Annuities. Retrieved from https://www.womanslife.org/annuities/
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