What Is a Deferred Annuity?
A deferred annuity is an insurance product that allows you to save for retirement while deferring taxes on the investment growth.
With a deferred annuity, you make payments into the account during your working years, and the money grows tax-deferred. When you retire, you can start withdrawing from the account and paying taxes on the earnings.
How Does a Deferred Annuity Work?
Deferred annuities have two phases: the accumulation phase and the payout phase.
During the accumulation phase, you contribute to the annuity, and the money grows tax-deferred. This means you do not have to pay taxes on the investment growth until you start withdrawing from the account.
The payout phase begins when you retire and start taking withdrawals from the account. With a deferred annuity, you can choose to receive the payments as a lump sum, or you can elect to receive them over a period of time (such as for 20 years).
When you start taking withdrawals, you will pay taxes on the investment growth that has accumulated in the account.
Types of Deferred Annuities
There are two main types of deferred annuities: fixed and variable.
A fixed deferred annuity pays a guaranteed interest rate, so you know exactly how much your account will grow each year.
On the other hand, a variable deferred annuity invests your money in market-based securities, so the growth potential is higher, but there is also more risk.
Benefits of a Deferred Annuity
There are many benefits of a deferred annuity, including:
- Tax-Deferred Growth: One of the biggest advantages of a deferred annuity is that your money can grow tax-deferred. This means you don't have to pay taxes on the investment growth until you start withdrawing from the account.
- Flexibility: With a deferred annuity, you can choose how and when you want to receive your payments. You can take a lump-sum withdrawal or elect to receive payments over a period of time (such as 20 years).
- Guaranteed Income: Another benefit of a deferred annuity is that it can provide you with a guaranteed income stream in retirement.
With a fixed annuity, you will know exactly how much money you will receive each month. With a variable annuity, you can elect to receive payments that are based on the performance of the underlying investment options.
Risks of a Deferred Annuity
There are some risks associated with a deferred annuity, including:
- Market Risk: If you invest in a variable annuity, your account balance will fluctuate based on the performance of the underlying investment options. This means that you could lose money if the market goes down.
- Inflation Risk: Another risk to consider is inflation. If inflation increases, your annuity payments' purchasing power could go down.
- Withdrawal Penalties: If you withdraw money from your annuity before you reach retirement age, you may be subject to withdrawal penalties.
Deferred Annuity vs Immediate Annuity
One of the main differences between a deferred annuity and an immediate annuity is when the payout phase begins.
With a deferred annuity, you defer taxes on the investment growth until you start taking withdrawals from the account (usually in retirement).
With an immediate annuity, on the other hand, you begin receiving payments immediately after you make the initial investment.
Another difference between these two types of annuities is that, with a deferred annuity, you can choose how and when you want to receive your payments.
With an immediate annuity, you typically have to commit to receiving payments for a certain period of time (such as 20 years), and you may not be able to get your money out of the account if you need it before the end of the payout phase.
The Bottom Line
A deferred annuity is an insurance product that can provide you with a guaranteed income stream in retirement.
A deferred annuity has many benefits, including tax-deferred growth and the flexibility to choose how and when you want to receive your payments.
However, there are some risks to consider as well, such as market risk and inflation risk.
Before you decide to invest in a deferred annuity, be sure to understand all of the features and risks involved.
FAQs
1. What is a deferred annuity?
A deferred annuity is an insurance product that allows you to defer taxes on the investment growth until you start taking withdrawals from the account.
2. How does a deferred annuity work?
With a deferred annuity, you make an initial investment and then defer taxes on the investment growth until you start withdrawing from the account.
3. What are the benefits of a deferred annuity?
Some of the benefits of a deferred annuity include tax-deferred growth and the flexibility to choose how and when you want to receive your payments.
4. What are the risks of a deferred annuity?
Some of the risks associated with a deferred annuity include market risk and inflation risk.
5. What is the difference between a deferred annuity and an immediate annuity?
One of the main differences between a deferred annuity and an immediate annuity is when the payout phase begins.
With a deferred annuity, you defer taxes on the investment growth until you start taking withdrawals from the account. With an immediate annuity, on the other hand, you begin receiving payments immediately after you make the initial investment.
