A deferred annuity is a common annuity form for people looking for retirement income. An annuity is a financial product that disburses funds over time, generally during retirement, to help seniors have a steady income. Depending on how close they are to retirement, investors in deferred annuities might contribute money in a lump sum or over time and postpone receiving an income stream until later—possibly decades later.
Here are some specifics on delayed annuities, including who should consider them and their main benefits.
How deferred annuities operate
You must first have a solid understanding of how annuities operate in order to comprehend what a deferred annuity is.
A contract known as an annuity, which is typically with an insurance company, provides income over a certain period of time in exchange for an up-front payment. According to the terms of the contract, the annuity will normally make payments on a monthly basis, frequently until the customer’s death, and it may also offer survivor’s benefits. One of these benefits could be an income source for a few beneficiaries after the customer has passed away.
The safety of an annuity may be one of its most alluring features. The insurance provider frequently provides a specific rate of return on the funds in the account or promises you a minimum payout amount. It might also provide death benefits on the annuity, which are normally payments made similar to life insurance after the account holder passes away.
The moment the client, or annuitant, receives the funds transforms an annuity into a delayed annuity. You can get your payments in two main methods.
With a deferred annuity, clients can make contributions throughout their whole working lives by adding a small amount from each paycheck to their annuity. Of course, they are also free to make a one-time payment. However, the crucial aspect is that they consent to get their benefit at a later time, typically years later.
In contrast, a client deposits a large sum and starts receiving payments from the income nearly immediately with an immediate payment annuity.
Additionally, annuities can vary in terms of their organizational design. Fixed annuities, variable annuities, and indexed annuities are the three main forms. It’s crucial that customers understand what they’re getting before they buy because the risks and rewards on these can vary significantly.
These classifications are not all-inclusive. Whether you select a fixed, variable, or indexed annuity structure, you must decide when it will pay out. That is, you can have an immediate fixed annuity, a deferred fixed annuity, a deferred variable annuity, etc.
Deferred annuity types
The annuity’s composition has an impact on how interest accrues during the accumulation phase. Therefore, the ideal type of annuity for you will depend on your investing needs and objectives.
A set price
The insurer guarantees a minimum yield on fixed annuities. The guaranteed minimum makes these investments the ideal choice for those with a reduced risk tolerance even though the return on this sort of annuity can be lower than other types. There is no inflation protection with this particular annuity kind.
Variable annuities do not have a minimum rate of return that is ensured, unlike fixed annuities. Your funds are invested in structures known as sub-accounts that include securities like stocks, bonds, and money market accounts.
With this kind of annuity, the return on your investment is based on the success of the investments; in other words, if they perform well, you may be able to earn more than you would with other annuities. They might therefore be able to serve as an inflation hedge. With a variable annuity, returns could be lower or even negative if your assets perform poorly.
In terms of performance and predictability, indexed annuities fall in the middle between fixed and variable annuities. These investments’ performance is correlated with a market index, like the S&P 500, thus the better the index does, the better your returns will be. As a result, indexed rate annuities can also act as a hedge against inflation.
Indexed annuities have a minimum rate that is guaranteed as well as a maximum return. With a variable annuity, you can get a higher return than fixed annuities while taking on a smaller risk of potential loss.
Length of deferred annuity payments
Depending on how your annuity is set up, the way it pays out may also change. Depending on when you need the money, you can choose from a variety of options.
Deferred lifetime annuities
You can choose to receive future payments from lifetime deferred annuities that will last the rest of your life. No of how long you live, you will continue to receive payments until you pass away. However, even if you don’t live long after payments begin, they will end once you pass away.
Term or fixed-period deferred annuities
Term deferred annuities, commonly referred to as fixed-period annuities, are a type of annuity that pays out over a predetermined time frame. For instance, it might pay off after ten or twenty years. You can designate a beneficiary to receive payments if you pass away suddenly while the payment period is still in effect. Payments will stop at the conclusion of the period even if you are still alive.
Benefits of deferred annuities
A retiree may benefit from a deferred annuity in a number of ways, some of which are common to annuities in general. These benefits consist of:
- Gains that are tax-deferred – A deferred annuity, like all annuities, enables a saver to accumulate money inside a tax-advantaged account. You can invest in an annuity on a tax-deferred basis, which means that you won’t pay taxes on the account’s earnings until you take them out. Additionally, any donations you make to the account with post-tax funds have no additional income tax due.
- contributions are limitless – You can contribute an unlimited amount to the account, just like all annuities. Higher earnings who max out their regular 401(k), which offers comparable tax-deferral benefits, and still desire to defer taxes on investment gains, may find that to be a considerable advantage.
- Variety of benefits: Annuities may provide a variety of advantages, including death benefits, survivor’s benefits, a minimum guaranteed lifetime payout, and other characteristics. All of these are included in the annuity’s cost.
- The influence of time A deferred annuity delays your payout to give your money more time to compound, which is likely to increase the payout you’ll be able to get when it’s time to start making withdrawals. In general, the payout may increase the longer your annuity is postponed.
Problems with a deferred annuity
A deferred annuity has certain definite disadvantages, some of which are significant, despite its benefits.
These shortcomings include:
- Complexity – An annuity contract may be protracted and intricate, with many crucial aspects buried in the small print.
- High costs – The costs associated with your investment might be significant, particularly the sales commission, which can easily reach 6 or 7 percent. However, some annuities may incur even additional charges. Read the small print thoroughly.
- Illiquid – Getting your money out of the annuity may be difficult, if not impossible. If you break your contract, you could have to pay additional fees like a surrender charge.
- penalties for withdrawing too soon – If you take money out of an annuity before age 59 1/2, you risk losing the tax-deferral benefits of the contract and perhaps incurring a bonus penalty.
Before making an investment, Chad Hamilton, CFP, senior vice president for practice management at Mariner Wealth Advisors, advises that you should thoroughly comprehend the product.
“For instance, you may need to decide to switch on income – or annuitize – the account in order to reap the benefit of a guaranteed income product,” explains Hamilton. The principle of the investment account is no longer accessible to you, and it becomes a stream of income instead. Typically, that decision is irrevocable.
Who ought to think about a deferred annuity?
Because annuities provide a fixed income stream when a person is no longer able to work, they can often meet their needs. They do, however, have several glaring shortcomings.
According to Hamilton, “Someone who is close to retirement and will require income in the near future may wish to explore a delayed annuity for a portion of their assets.”
This annuity provides a lot of security for a retiree, especially when combined with Social Security, when the deferral feature is combined with a fixed contract that guarantees a minimum rate of return on your investment. (The typical Social Security payment for seniors is shown here.)
Consider a variable deferred annuity if you want some of the possible investment returns from stocks without some of the dangers. The investor in a variable annuity invests money in stock mutual funds among other things, and there can be a minimum guaranteed income.
To sum up
Deferred annuities can be a wise choice for the right individual at the right time, but they have significant drawbacks that prospective investors should be well aware of before signing up. Annuities continue to be a popular retirement investment vehicle despite these costly drawbacks, in part because to how lucrative it is for the agent selling them and in part due to the infinite capacity to put money into a tax-deferred investment vehicle.