Deferred annuities are a financial tool designed to build wealth and create lifetime retirement income. This type of investment allows your money to accumulate tax-free for a set period of time. Many people enjoy the benefits of guaranteed payments from deferred annuities, but this option isn't right for everyone.
Fortunately, an independent insurance agent can help you decide if a deferred annuity is the right choice. They'll help you compare and understand your options so you can make an informed decision. But first, you can use our guide to better understand what deferred annuities are, how they work, and why you might want to invest in one.
Key Takeaways - What Is a Deferred Annuity?
- A deferred annuity is an investment option that allows your money to grow tax-free for a period of time.
- Deferred annuities are the preferred retirement savings option for many people.
- Taxes are only paid on the deferred annuity when the funds are withdrawn.
- It's highly recommended to work with an independent insurance agent, as they can help you compare your options and understand if a deferred annuity is the right choice.
Important Annuity Terminology to Understand
An annuity policy is a contract between an insurance company and:
- The owner: This person has the sole right to the values and payments in the contract. The owner decides who the annuitant and beneficiaries are.
- The annuitant: This person receives the annuity, and can be someone other than the owner. The age and sex of the annuitant are how the insurance company determines how much and when income is paid.
- The beneficiary: This person receives the proceeds at the death of the owner or annuitant.
The insurance company issues and promises to honor the annuity policy. However, the policy's guarantees are only as good as the company's financial ability to pay claims. That's why it's critical to work with an independent insurance agent to get an annuity from a financially sound carrier.
What Is a Deferred Annuity?
The definition of a deferred annuity is a binding contract with an insurance company to create an investment account that allows your money to accumulate tax-free for a set period of time. Later, this account will be converted into a series of guaranteed income payments. You can buy a deferred annuity policy by making a single payment or a series of payments.
- Single premium deferred annuity: With this type of annuity, you make just one lump-sum payment into the account, and this amount grows over time.
- Flexible premium deferred annuity: With this type of annuity, you make multiple periodic payments over time, similar to a retirement or savings account.
There are benefits to both of these types of tax-deferred annuities. An independent insurance agent can help you decide which type of deferred annuity plan makes the most sense.
How Does a Deferred Annuity Work?
Deferred annuities have two phases: accumulation and payout. During the accumulation phase, the account's value grows tax-deferred. This means that no tax on interest or gains is paid until the money is withdrawn. In the payout phase, the insurance company pays the lifetime income to the owner or annuitant.
The Main Types of Deferred Annuities
There are several types of deferred annuity plans that you can choose from, including the following:
- Traditional qualified deferred annuities: These are part of a pension plan or IRA. They are purchased with before-tax dollars.
- Roth-qualified deferred annuities: These are part of a Roth IRA or pension. They are purchased with after-tax dollars.
- Non-qualified deferred annuities: These are personally owned and paid for with after-tax dollars.
Deferred annuities examples include a fixed deferred annuity, a variable deferred annuity, and an indexed deferred annuity. Your independent insurance agent can help you pare down your options to select the best type of annuity for your retirement and investment goals.
What Is a Fixed Deferred Annuity?
Fixed deferred annuities are an investment option that offers competitive, low-risk returns. The values of a fixed annuity are guaranteed by the insurance company. The guarantees apply to:
- The cash value: These are the payments accumulated at the interest rates applied.
- The surrender value: This refers to the cash value minus any charges for cashing in the policy.
- The annuity payout factors: This refers to the rate applied to calculate annuity income.
- Minimum interest rate: This is applied to the cash value.
Fixed annuity interest rates are usually higher than CD or savings account rates.
What Is a Fixed Index Deferred Annuity?
Fixed index annuities have the same features as fixed annuities with one key difference. Fixed index annuities offer tax-deferred growth based on the stock market without stock market risk. Index accounts credit some of the gains of a market index like the S&P 500 and none of the losses.
What Is a Variable Deferred Annuity?
Deferred variable annuities accumulate money in investments selected by the owner, called subaccounts. Like mutual funds or other investments, the values of the subaccounts are based on market performance and aren’t guaranteed. Money can be transferred between subaccounts without any tax consequences. Variable annuities have features that offer “downside protection” to investors during down markets.
How Do I Get Income from a Deferred Annuity?
The answer depends, because there are many options for deferred annuities. Some options exchange account values for income, and others leave account values available. Here's a closer look at how income is gained from deferred annuities.
| Type of Plan | During Lifetime | At Death | Advantages | Disadvantages |
|---|---|---|---|---|
| Life | Pays income for the annuitant’s life. | None. | Highest income. Partly taxable. | No refund of unused principle. |
| Life and 10 Years Certain | Pays income for life. Not less than 10 years. | Balance if death occurs before the end of 10 years. | Protection for beneficiaries. Partly taxable. | Lower income. |
| Life and 20 Years Certain | Pays income for life. Not less than 20 years. | Balance if death occurs before the end of 20 years. | Protection for beneficiaries. Partly taxable. | Lower income. |
| Life With Cash Refund | Pays income for life. Payments are at least the specified refund amount. | Balance of refund amount. | Protection for beneficiaries. Partly taxable. | Lower income. |
| Period Certain | Pays income for a specified number of years. | Balance of payments. | Useful for certain planning purposes. | Outliving income. |
| Joint & Survivor 100% | Pays income for the longer of the two lives. | No further payments at the second death. | Surviving spouse continues to receive income for life. Partly taxable. | Lower income. |
| Guaranteed Lifetime Withdrawal Benefit Single Life | Pays income for the annuitant’s life. | Balance of account. | Access to account values, death benefit. | Income taxed as withdrawals. |
| Guaranteed Lifetime Withdrawal Joint Life | Pays income for the lifetime of the annuitant and the second life. | Balance of account at second death. | Access to the account, death benefit. | Income taxed as withdrawals. |
Is a Deferred Annuity Right for Me?
Whether a deferred annuity is right for you depends on your unique retirement, investment, and savings goals. Here are some considerations when determining if a deferred annuity is the best choice.
- Tax-deferred growth is a major benefit of annuities. Is tax control important to you? Can you benefit from tax-deferred growth?
- Deferred annuities have surrender and tax penalties. Do you have adequate resources for emergencies and other short-term needs?
- Deferred annuities can guarantee an income for life. Do you want a fixed, guaranteed income for life instead of income that may benefit from market returns?
- Deferred annuities can offer downside market protection and other benefits. Do these options enhance your retirement plan?
If you're still unsure of whether a deferred annuity is the best option, ask an independent insurance agent for more information. They can help you weigh all the choices available when it comes to annuities and other types of retirement savings accounts.
An Independent Insurance Agent Can Help You Find the Right Deferred Annuity
Deferred annuities can be an important part of your retirement plan. While they have many features and benefits, they are not for everyone. A local independent insurance agent can help you decide if a deferred annuity is the right fit. They have access to multiple companies, so they're free to shop and compare the best deferred annuity plans and rates for you.
Sources
Advisor’s guide to annuities John Olsen
Fundamentals of Investments Wilson & Hopkins
NAIC Buyers guide to deferred annuities
IRS PUB 575
IRS PUB 410
Fitch Ratings Definitions
Moody’s rating scale and definition
S&P Global Understanding Ratings
A.M. Best Why An A.M. Best Financial Rating Is Important
The American College of Trust and Estate Counsel State Survey of Asset Protection Techniques
https://www.guardianlife.com/annuities/deferred
