Annuities can essentially be placed into two categories depending on their distribution options: immediate or deferred. Deferred Annuities are a type of annuity contract that delays the payments of income, installments or a lump sum until the investor elects to receive them.
Annuities can essentially be placed into two categories depending on their distribution options: immediate or deferred. Deferred Annuities are a type of annuity contract that delays the payments of income, installments or a lump sum until the investor elects to receive them.
This type of annuity has two main phases, the accumulation phase in which you invest money into the tax deferred account, and the income or payout phase in which the plan is converted into an annuity and payments are received. Please note the not all annuities require a payout period, many offer the option to take the funds out in a lump sum after a set number of years (typically 5-10 years).
Acting much like a CDs, deferred annuities accumulate interest over time. This differs from a fixed immediate annuities, which pay out in monthly installments as soon as the contract starts (typically after 30 days).
Even though deferred annuities are designed to accumulate money, most annuity contracts include a "free withdrawals" provision, which allows the owner to take out anywhere from 5%-20% per year penalty free, depending on the specific contract rules. Any amount taken beyond this limit is subject fees and surrender charges, so be sure to ask your financial professional what amount would be available to you each year.
The most significant benefit deferred annuities offer over CDs and other similar investment
vehicles is tax-deferral. A CD would be taxed yearly and annuity income isn't taxed until it's withdrawn. The result of this is that 100% of the interest accumulated each year in a deferred annuity would stay in the policy and continue to compound interest.
The advantages of tax-deferral really start to kick-in over time, so it's in the deferred annuity investor's interest to opt for longer terms. An ideal deferred annuity investor starts saving for retirement early and gives plenty of time for the account to compound.
Another important benefit of deferred annuities is their multi-premium nature, allowing you to start with a smaller investment. One problem with immediate annuities is that they need to be funded with large up front premiums, which isn't always available. This is necessary because payouts start immediately and there's no time for your money to grow. A deferred annuity, however, like a 401(k), is designed to accommodate continuing contributions throughout the contract term. This allows investors to start small and work their way up to a sizable retirement nest egg incrementally.
The key difference between immediate and deferred investments is the function they're designed to
fulfill. An immediate annuity is appropriate when you require consistent monthly income, as for retirement. A deferred annuity is appropriate when you want to put money away for retirement, but not use it today.
If you're already retired, or need a steady stream of income, immediate fixed annuities are the best choice. If you're just starting to save for retirement, or still have 5-10 years before you need the money, deferred annuities offer a better return.
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