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What is a deferred annuity?

Learn about deferred annuities including how they work, different types, and some pros and cons to consider in this article from Protective.

What is a deferred annuity?

A deferred annuity is a financial product offered by an insurance company that allows you to invest money now to receive regular income payments in the future. They are commonly used as a tool to supplement retirement income, offering a reliable stream of funds to cover living expenses during retirement when traditional income sources, such as your salary, may no longer be available.

How does a deferred annuity work?

When purchasing an annuity from an insurance company, there are typically two main forms of annuities you can buy, an immediate annuity or a deferred annuity. Both types are typically purchased for their ability to generate a guaranteed income stream in retirement. However, only the deferred annuity includes an "accumulation phase" during which your annuity contract will have an opportunity to grow in value before income payments are initiated.

Unlike immediate annuities that are purchased with a single-lump sum payment and start paying out immediately after purchase, a deferred annuity can often be purchased through a lump-sum or with a series of payments and can allow you the flexibility to choose when you want to receive the income payments. This delay in income gives your funds the opportunity to grow over time, and potentially provides a larger income stream when you begin taking income from the contract.

Types of deferred annuities

Choosing the right annuity is important because there’s no one-size-fits-all solution. Before making your selection, it’s essential to understand the two other categories of deferred annuities: single premium and flexible premium. Whether you prefer the simplicity of a one-time payment or the flexibility of regular contributions, there’s a funding option for either approach.

Single premium deferred annuities

A single premium deferred annuity is a financial product that can help you save for the future and provide a guaranteed stream of income later in life. Purchased through a lump-sum payment, your funds can grow tax-deferred over several years. After this period, you can initiate regular income payments that can last for a set period or the rest of your life, providing you with a reliable source of income during retirement.

Flexible premium deferred annuities

A flexible premium deferred annuity is a financial product that allows you to make investments over time, rather than in one lump sum, and you delay receiving payments until a future date.

Phases of a deferred annuity

Prior to evaluating your deferred annuity options, it is important to understand the phases of an annuity.  Deferred annuities typically have two phases:

Accumulation  a period of time during which the annuity can grow in value. This will often occur before an individual retires.

Distribution  The payout phase of an annuity comes when the accumulated value is distributed, either via a lump sum or a series of payments over time.

Deferred annuities grow on a tax-deferred basis, and you will only pay taxes when you make a withdrawal, take a lump sum or begin receiving income from the contract*.

Deferred annuity accumulation phase

Now that you know a little about the different phases, let’s take a deeper dive into accumulation phase and how it works. The accumulation phase is the period in which you contribute to an annuity through a series of payments or a lump sum. During this period, the annuity has an opportunity to build value.

Ultimately, how the accumulation phase will work will depend on the type of deferred annuity selected and the features that are included. There are three common types of deferred annuities to choose from: fixed, indexed, and variable.

Variable deferred annuities

Variable annuities are a type of deferred annuity designed to accumulate contract value using mutual fund-like investment options. During the accumulation phase, payments are allocated to variable annuity subaccounts, which in turn invest in stocks, bond funds or money market funds. While they offer the potential for greater earnings compared to other types of annuities, variable annuities also come with greater investment risk and the potential for loss of your principal investment.

Fixed deferred annuities

Fixed annuities are a type of deferred annuity designed to preserve and accumulate capital to carry into retirement. During the accumulation phase, your investment earns a guaranteed interest rate set by the insurance company. This rate will remain constant through the accumulation period or be locked in for a set period, depending on the annuity.

Indexed deferred annuities

Indexed annuities are a type of deferred annuity designed to accumulate value by tracking a market index. Indexed annuities allow opportunity for your money to grow with downside protection to limit risk to your investment. During the accumulation phase, your investment can grow over time based on the performance of a specified market index, such as the S&P 500. Your principal is protected from negative returns with positive returns limited by a cap set by the insurance company.

Deferred annuity payout phase

The payout phase comes after the accumulation phase. It is also known as the annuitization phase. In this phase, the life insurance company distributes payments from the deferred annuity to the payee, typically the owner. These payments can be paid out in a lump sum over a set number of years, or for even the rest of your life.

Advantages of deferred annuities

A deferred annuity is a retirement investment vehicle that can offer benefits, including:

Guaranteed lifetime income — Annuities can give you a steady stream of income for a set period of time or for your lifetime.

Tax-deferred growth  Any growth within your annuity is tax-deferred until you withdraw it*.

Death benefit  An annuity can pay money directly to your beneficiaries if you die during the accumulation phase, helping them avoid a lengthy probate process.

Disadvantages of deferred annuities

Despite its advantages, a deferred annuity can also have some drawbacks. Here are a few to consider:

Withdrawal penalties  Withdrawals from a deferred annuity may be subject to surrender charges as well as a 10% tax penalty if the owner is under age 59 1/2*.

Surrender charges  deferred annuities often come with surrender charges if you withdraw more than a certain percentage of your account value within a specified period, typically within the first several years of the contract.

Market volatility  while some deferred annuities offer guaranteed minimum returns or protection from market downturns, others are linked to the performance of underlying investments, exposing you to market risk.

Is a deferred annuity right for you?

If you are seeking to supplement your retirement income with a steady stream of payments, a deferred annuity might be worth consideration. Likewise, for those looking to defer taxes on investments gains and establish a reliable source of income for the future, a deferred annuity may align with these financial goals.

It’s important to evaluate your unique financial situation, risk tolerance and retirement objectives before purchasing any annuity. Consulting with a qualified financial professional can provide personalized guidance and help find a product that best fits your needs and objectives.

Key takeaways

  • A deferred annuity is a financial product offered by an insurance company that allows you to invest money now to receive regular income payments during retirement.
  • Deferred annuities typically have two phases: accumulation and distribution.
  • Accumulation is the period of time when the contract can grow in value.
  • Distribution is when the contract value is distributed back to the annuitant through either a lump sum or a series of payments over time.
  • There are three main types of deferred annuities to choose from: Fixed, Indexed, and Variable.
  • There are many advantages and risks when purchasing a deferred annuity, so it’s important to work with a financial professional to identify the best product to fit your unique needs.

* Annuity payments from a tax-qualified plan will be fully taxable as ordinary income. Annuities are intended as vehicles for long-term retirement planning, which is why withdrawals reduce an annuity's remaining death benefit, contract value, cash surrender value and future earnings. Annuities also may be subject to income tax and, if taken prior to age 59 ½, an additional 10% IRS tax penalty may apply.





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All Learning Center articles are general summaries that can be used when considering your financial future at various life stages. The information presented is for educational purposes and is meant to supplement other information specific to your situation. It is not intended as investment advice and does not necessarily represent the opinion of Protective or its subsidiaries.

Learning Center articles may describe services and financial products not offered by Protective or its subsidiaries. Descriptions of financial products contained in Learning Center articles are not intended to represent those offered by Protective or its subsidiaries.

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