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When your annuity income stream is delayed, or deferred, after you purchase the annuity, this is known as a deferred annuity. This differs from an immediate annuity, which begins payments to you within a year of purchase.
When you purchase an annuity, you will decide whether you want to begin receiving payments within a year, which is known as an immediate annuity, or at some point in the future, known as a deferred annuity.
Deferred annuities allow your investment to build over time before you begin to receive the stream of payments. Typically, annuities, such as qualified longevity annuity contracts, are bought for future retirement income.
According to the LIMRA Secure Retirement Institute, deferred annuities are forecast to have the largest growth rates over the coming years.
Accumulation and Payout Phases
There are two phases to a deferred annuity: The accumulation phase and the payout phase.
During the accumulation phase, you are making payments and your annuity is accumulating interest on a tax-deferred basis. How this accumulation occurs varies depending on the annuity type.
If you have a contract for a fixed annuity, your financial investment will accrue interest at a fixed rate that will not drop below a minimum, guaranteed by the issuing company.
Variable annuity contracts allow insurers to invest your premiums in mutual funds that comprise stocks, bonds and other short-term money market products called sub-accounts. Your rate of return depends on the performance of your sub-accounts. This interest-earning rate is the most common for deferred annuities.
Indexed annuities are tied to the performance of stock-market measurements, including Standard & Poor’s index of 500 stocks, commonly known as the S&P 500. Your contract guarantees a minimum interest rate that can’t drop — even if the stock market index falls.
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.
You don’t pay taxes on those earnings during the accumulation phase. Taxes are not due until you reach the payout phase.
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.
Single vs. Multiple Premium
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.
Single Premium Deferred Annuities
Single premium deferred annuities are purchased with one sum of money in one payment.
Multiple Premium Deferred Annuities
A multiple premium annuity is a type of deferred annuity that is purchased with a series of payments. These payments can be scheduled as specific amounts — what’s known as scheduled premium deferred annuities — or they can change according to your plans or ability to pay. A deferred annuity that allows you to adjust your payments in this way is known as a flexible premium deferred annuity.
Once an annuitant reaches 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.
In a lump sum disbursement, an annuity is distributed as a one-time, taxable single payment.
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.
Pros and Cons of Deferred Annuities
As with any investment, deferred annuities carry a number of benefits and risks.
- Tax-Deferred Investment
- Annuitants pay taxes only once the money has been withdrawn.
- Guarantees Against Loss
- Most deferred annuity contracts have built-in guarantees against loss of principal or offer guaranteed rates of return.
- Lifetime Benefits
- If you annuitize your contract, insurance companies guarantee lifetime payments for you or your spouse until your deaths.
- Death Benefits
- 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 upper limits on the principal amount you can contribute to a deferred annuity.
- Lack of Liquidity
- 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 Internal Revenue Service for any withdrawal you make before you are at least 59½.
- High Tax Rates on Earnings
- The IRS can tax annuity earnings at the ordinary income rate, which may be higher than the capital gains rate applied to investments in stocks, for example.
- Additional Expenses
- Maintaining a deferred annuity contract can be expensive for all of the excess charges, including administrative fees, funding expenses, charges for special features, riders (additional policy benefits) and commissions for salespeople.
9 Cited Research Articles
- Anspach, D. (2018, October 28). What a Deferred Annuity Is and How It Works? Retrieved from https://www.thebalance.com/all-about-deferred-annuities-2389020
- 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/
- Cotton, D. (2017, November 8). Income Annuities: Immediate And Deferred. Retrieved from https://seekingalpha.com/article/4122646-income-annuities-immediate-deferred
- Financial Web. (n.d.) Immediate and Deferred Annuities. Retrieved from https://www.finweb.com/insurance/immediate-and-deferred-annuities.html
- Investopedia. (n.d.). Deferred Annuity. Retrieved from https://www.investopedia.com/terms/d/deferredannuity.asp
- LIMRA. (2018, June 7). LIMRA Secure Retirement Institute Forecasts Total Annuity Sales to Improve Through 2019. Retrieved from https://www.limra.com/Posts/PR/Industry_Trends_Blog/LIMRA_Secure_Retirement_Institute_Forecasts_Total_Annuity_Sales_to_Improve_Through_2019.aspx
- National Association of Insurance Commissioners. (2013). Buyer’s Guide to: Fixed Deferred Annuities. Retrieved from https://www.nj.gov/dobi/division_insurance/pdfs/naicdeferredannuities.pdf
- National Association of Insurance Commissioners. (n.d.). 10 Things You Should Know About Buying Fixed Deferred Annuities. Retrieved from https://www.michigan.gov/documents/cis_ofis_naic_alert_annuities_142656_7.pdf
- Woman’s Life Insurance Society. (n.d.). Fixed Deferred Annuities. Retrieved from https://www.womanslife.org/annuities/