Deferred Annuities

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

What is A Deferred Annuity?

A deferred annuity contract delays the payment of income (in a lump sum or a series of payments) until the investor elects to receive it.

Deferred Annuity Basics

  • Deferred Annuity Definition: A deferred annuity is an insurance product that allows you to accumulate interest on your tax-deferred principal until you start receiving payments.
  • Single Premium Deferred Annuity (SPDA): This is where you make a one-time payment into the annuity. The annuitant in a single premium deferred annuity is the person who will receive the payments in the future.
  • Flexible Premium Deferred Annuity: Unlike the SPDA, this allows you to make multiple payments over time.
  • Deferred Annuity Meaning: A tax-deferred annuity is a pension-like long-term savings account for growth and future income.

Helpful Tool: Deferred Annuity Calculator

Key Takeaways

  • They have an accumulation period (where you pay in or your investment grows) and a payout period (when you receive payments).
  • They offer a death benefit, paying out the value to your beneficiaries if you die during the accumulation phase.
  • Early withdrawal may lead to surrender charges, though some annuities allow limited free withdrawals.
  • Earnings are tax-deferred until you make withdrawals.
  • Optional features or riders can be added, often at an extra cost.

How Do Deferred Annuities Work?

During the accumulation phase, your money grows tax-deferred. Interest earnings accumulate, and you don’t pay taxes until you make withdrawals. This is one of the primary benefits of a deferred annuity. The annuity can be surrendered during this period, but it’s essential to understand when surrender charges apply to deferred annuity contract surrenders.

  • Accumulation Phase: This is when the investor makes payments into the annuity. These contributions grow on a tax-deferred basis, meaning the earnings aren’t taxed until they are withdrawn.
  • Annuitization Phase: This phase kicks in when the investor chooses to start receiving payments from the annuity, usually upon retirement. The frequency of these payments can range from monthly to annually, depending on the specific contract.
 Deferred Annuity

Deferred Annuity At A Glance

Fixed Index
Principal ProtectionNoYesYesYesYes
Access To PrincipalYesYesYesNoNo
Control Over MoneyYesYesYesNoNo
Tax-Deferred GrowthYesYesYesNoNo
Guaranteed GrowthNoYesYesNoNo
Guaranteed IncomeYesYesYesYesYes
Inflation ProtectionYesYesNoYesYes
Death BenefitYesYesYesMaybeMaybe
Long-Term Care HelpYesYesYesNoNo

Types of Deferred Annuities

  • Fixed Deferred Annuity: Offers a guaranteed interest rate. Its stable and predictable growth distinguishes a fixed deferred annuity from other types.
  • Variable Deferred Annuities: These allow you to invest in sub-accounts, similar to mutual funds. The returns on a variable deferred annuity can fluctuate based on the market’s performance.
  • Indexed Deferred Annuity: Tied to a market index, like the S&P 500. It offers a guaranteed minimum interest rate and an interest rate linked to market performance.
  • Group Deferred Annuity: This contract is purchased for a group of people, often by employers for their employees.
 What Is A Deferred Annuity?

Key Features and Terms to Know

  • Guaranteed Lifetime Withdrawal Benefit: Allows you to withdraw a set amount of money annually, regardless of the annuity’s value.
  • Annuitization: The optional process of converting your deferred annuity into income payments.
  • Surrender Charge Period: If you surrender your contract during this timeframe, you may be subject to a penalty.
  • Bonus Rate: Some annuities offer a higher initial interest rate for the contract’s first year.
  • Maturity Date: When your deferred annuity’s value is paid out in a lump sum or converted into income payments.
  • Deferred Annuity Death Benefit: If the annuitant passes away during the accumulation phase, most deferred annuities guarantee a death benefit to beneficiaries.
  • Surrender Charge: This fee is imposed if you withdraw funds from your annuity before a specified period. The purpose of the surrender charge in a deferred annuity is to compensate the insurance company for early withdrawal.
Single-Premium Deferred Annuities And Flexible Premium Deferred Annuities

Deferred Annuities Pros And Cons

Pros of Deferred AnnuitiesCons of Deferred Annuities
Tax Deferral: The investment grows tax-free until withdrawal, allowing the money to compound and grow more rapidly.Surrender Charges: Early withdrawal can lead to hefty fees, limiting access to your funds for several years.
Income for Life: They can provide a steady stream of income during retirement, reducing the risk of outliving your savings.Taxation upon Withdrawal: Earnings are taxed as ordinary income when withdrawn, which can be higher than capital gains taxes.
Flexible Investment Options: Depending on the type, you may have a choice between fixed, variable, or indexed returns, allowing for diversification.Investment Risk with Variable Annuities: The return rates on variable or indexed annuities can fluctuate with market changes, potentially impacting retirement income.
Death Benefits: Many offer a death benefit option, where your beneficiary will receive a guaranteed minimum amount.Fees and Commissions: There can be high management fees, mortality and expense charges, or commissions associated with the annuity.
Guaranteed Minimum Returns: Especially with fixed deferred annuities, there’s a safety net of minimum interest rates.Inflation Risk: Fixed payouts might not keep up with inflation, potentially reducing purchasing power over time.

How Does a Tax-Deferred Annuity Work?

Imagine planting a seed in fertile soil. Over time, with the proper care, it grows into a robust tree. Similarly, when you invest in a tax-deferred annuity, your money—like that seed—can grow more robustly because yearly taxes are not pruning.

Here’s a simple breakdown:

  • Initial Investment: You start by purchasing the annuity through a single payment or multiple payments over time.
  • Growth Phase: Your investment grows tax-free. The interest and earnings compound without the drag of annual taxes.
  • Distribution Phase: When you’re ready, you start receiving payments. At this point, you’ll pay taxes on your earnings but not on your original investment.
Fixed Deferred Annuities, Variable Deferred Annuities, Indexed Deferred Annuities

Next Steps

In conclusion, understanding the definition of a deferred annuity and its features is crucial for any investor planning for a secure retirement. Deferred annuities could be a viable option for those looking for guaranteed, lifelong income post-retirement. However, consulting with a financial advisor to evaluate if this investment aligns with your financial goals and circumstances is always advisable. Your retirement is a time to relax and enjoy life. With proper financial planning, you can ensure it is just that.

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Questions From Our Readers

How are deferred annuities calculated?

The formula for calculating a deferred annuity is future value = present value × (1 + interest rate) number of periods. For example, if you have $10,000 in a deferred annuity that pays 5% interest and you plan to leave it invested for ten years, the future value of the annuity would be: $10,000 × (1 + 0.05)^10 = $16,105.05

Can you lose money with a deferred annuity?

You can lose money in a deferred annuity through early withdrawal penalties, investment losses in variable annuities, or fees and charges the issuing company applies. That’s why it’s important to research an insurer before buying an annuity. You can check an insurer’s financial strength rating at A.M. Best and Moody’s websites.

When should I buy a deferred annuity?

The best time to buy a deferred annuity is when you have the money you won’t need for at least seven years. This will give the annuity time to grow and compound without the risk of having to withdraw the money early. Also, remember that you may want to start taking Social Security benefits at age 62. It could reduce your Social Security benefits if you start receiving payments from a deferred annuity before that. So, you may consider waiting until age 62 to start taking payments from a deferred annuity.

How soon can benefit payments begin with a deferred annuity?

With a deferred annuity, you can choose when you want payments to begin. The most common choice is at retirement, but you can also choose to start receiving payments before or after retirement in as little as 30 days. If you start taking payments before age 59½, you may have to pay a 10% early withdrawal penalty.

What are the basic types of deferred annuities?

There are two basic types of deferred annuities: fixed and variable. With a fixed deferred annuity, the interest rate is guaranteed for a set period, usually 2 to 10 years. After that, the interest rate may change but never be lower than the guaranteed minimum rate. With a variable deferred annuity, the interest rate and your payments can go up or down depending on how the investments in the annuity perform.

How many phases does a deferred annuity have?

A deferred annuity has two phases: the accumulation and payout phases. You contribute to the annuity during accumulation, and the money grows tax-deferred. During the payout phase, you begin taking distributions from the annuity and pay taxes on the money as you withdraw it.

How do interest earnings accumulate in a deferred annuity?

Interest earnings in a deferred annuity accumulate tax-deferred, compounding over time until withdrawals are made in the future.

How soon can the benefit payments begin with a deferred annuity?

Depending on the contract terms, benefit payments can begin 30 days after purchasing a deferred annuity.

Who can surrender a deferred annuity contract?

Only the owner of a deferred annuity contract, not the annuitant or beneficiaries, can surrender it.

When do surrender charges apply to deferred annuity contract surrenders?

Surrender charges apply when withdrawing funds from a deferred annuity contract before the end of the surrender period, typically within 5 to 10 years from purchase.

What is the guaranteed minimum interest rate in a fixed deferred annuity?

The guaranteed minimum interest rate in a fixed deferred annuity is the lowest rate at which money will accrue interest, set by the insurance company at contract initiation.

Why do I have to wait ten years to benefit from my annuity?

This could be a specific term of a deferred annuity chosen for tax or growth reasons.

When do deferred annuity payments begin?

Deferred annuity payments typically begin at a future date chosen by the annuitant, often at retirement.

What is the primary benefit of a deferred annuity?

The primary benefit of a deferred annuity is tax-deferred growth of investments.

What is the deferred annuity formula?

The deferred annuity formula involves calculating the future value of an annuity based on regular contributions, interest rate, and time.

What does SPDA mean?

SPDA stands for Single Premium Deferred Annuity.

What is a Single Premium Deferred Annuity?

A Single Premium Deferred Annuity involves a one-time payment with benefits starting at a future date.

What is a tax-deferred annuity?

A tax-deferred annuity allows investment earnings to grow tax-deferred until withdrawals are made.

What is a Flexible Premium Deferred Annuity?

A Flexible Premium Deferred Annuity allows for multiple payments over time, with benefits starting in the future.

What is a Fixed Deferred Annuity?

A Fixed Deferred Annuity guarantees a fixed return, with payments starting at a future date.

What is a Deferred Variable Annuity?

A Deferred Variable Annuity involves investment in various assets with payments starting later.

What is a deferred annuity used for?

A deferred annuity is used for long-term financial planning, often for retirement savings.

What is a Deferred Annuity Pension?

A Deferred Annuity Pension is a retirement plan offering delayed payments.

How many types of deferred annuities are there?

There are several types of deferred annuities, including fixed, variable, and indexed.

How does a flexible premium deferred annuity work?

A flexible premium deferred annuity works by allowing varied contributions and deferring income.

Are tax-deferred annuities a good investment?

Depending on individual financial goals, tax-deferred annuities can be a good investment for long-term growth.

Are deferred fixed annuities a good investment?

Deferred fixed annuities can be a good investment for those seeking stable, guaranteed returns.

The type of annuity that can be purchased with one monetary deposit is called?

The type of annuity that can be purchased with one monetary deposit is called a single premium annuity. This annuity requires a lump sum payment upfront, providing a guaranteed income stream for the future.

How soon can the benefit payments begin with a deferred annuity?

With a deferred annuity, the start of benefit payments depends on the specific terms of the contract. Generally, the policyholder can choose when to begin receiving payments, such as at retirement age. However, it’s important to review the annuity agreement to understand any specific requirements or restrictions regarding when benefit payments can begin.

What are the different plans for Deferred Income Annuity?

Deferred Income Annuities (DIAs) come in different types, such as Variable Annuities and Fixed-Indexed Annuities with a Guaranteed Lifetime Withdrawal Benefit (GLWB). The key difference between these and traditional DIAs is in how income is generated and managed. With a GLWB, the owner retains control over the annuity’s principal and can withdraw a certain amount annually while still benefiting from a guaranteed income for life. On the other hand, traditional DIAs involve annuitization, where you convert your annuity into a stream of income, typically relinquishing control over the principal in exchange for the guarantee of a steady income.

What does a “5-year surrender” mean in a deferred annuity?

In a deferred annuity, a 5-year surrender period is a time frame, typically the first five years after purchasing the annuity, during which you’ll face a penalty if you withdraw more than a certain percentage of your funds. This penalty decreases each year until it disappears after the fifth year. After this period, you can access your money without facing surrender charges. This period helps the insurance company manage their risk and investment strategies.

When must you withdraw all your money from a single premium deferred annuity?

When must you withdraw all your money from a single premium deferred annuity? Generally, for a single premium deferred annuity, you are not required to withdraw all your money at any specific time during your lifetime. These annuities typically allow you to defer withdrawals indefinitely, with the understanding that at some point, usually by age 85 or 90, the contract may require annuitization or the start of distributions.

I have a nonqualified deferred annuity. Can I transfer to a bank into an IRA?

You can, but you don’t want to because the money you contributed to the annuity has already been taxed and will be taxed again. You will also be limited on future contribution limits.

How do I transfer my deferred annuity to my kids?

To transfer a deferred annuity to your children, you need to fill out a beneficiary designation form provided by the annuity company. On this form, you can name your children as beneficiaries.

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Shawn Plummer is a Chartered Retirement Planning Counselor, insurance agent, and annuity broker with over 14 years of first-hand experience with annuities and insurance. Since beginning his journey in 2009, he has been pivotal in selling and educating about annuities and insurance products. Still, he has also played an instrumental role in training financial advisors for a prestigious Fortune Global 500 insurance company, Allianz. His insights and expertise have made him a sought-after voice in the industry, leading to features in renowned publications such as Time Magazine, Bloomberg, Entrepreneur, Yahoo! Finance, MSN, SmartAsset, The Simple Dollar, U.S. News and World Report, Women’s Health Magazine, and many more. Shawn’s driving ambition? To simplify retirement planning, he ensures his clients understand their choices and secure the best insurance coverage at unbeatable rates.

The Annuity Expert is an independent online insurance agency servicing consumers across the United States. The goal is to help you take the guesswork out of retirement planning and find the best insurance coverage at the cheapest rates

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