A deferred annuity is a contract with an insurance company that promises to pay the owner a regular income at a future date. Unlike immediate annuities that make payments right away, a deferred annuity does not make payments immediately.
A deferred annuity is most preferred when you are approaching retirement. This is because you must have built up some savings. This will help you to fund the annuity and give you a push before you start getting your retirement income. Buying a deferred annuity is a major financial decision and therefore needs to be carefully researched before signing up.
Since the time frame to get your income is longer (about a year) than an immediate annuity, you may consider the latter if you need your income sooner than one year. However, you will need the expertise of a financial advisor to help you determine which type of annuity is best for you.
Types of Deferred Annuity
Every deferred annuity is classified based on its returns, terms, and funding style. It also implies your future annuity income. This is why this article has been written to help you understand which deferred annuity is best suited for you. The three basic types are explained below:
1. Fixed Annuity
A fixed annuity promises a specific guaranteed rate of return on the money in your account. It is known to be the safest option compared to a certificate of deposit.
It is also much smaller than market returns and this helps you know how much money you will have upon retirement. A fixed annuity has little or zero risks involved about your future retirement income but ensures your savings grow by at least some amount.
2. Index Annuity
An index annuity provides a return based on the performance of a particular market index like the S&P 500. It is often referred to as “one of the best of both worlds” because of its growth payment. If your market goes well, your money grows more and you earn less when your money does poorly.
One of the key advantages index annuity has is that it sets a limit on your highest possible gain and highest possible loss.
Therefore, you are guaranteed not to lose any of your initial investment. Index annuity has some unpredictability but not as much as a variable annuity.
3. Variable annuity
A variable annuity is based on the performance of a portfolio of mutual funds or sub-accounts, chosen by the annuity owner.
However, they have no guaranteed rate of return. They allow you to invest your savings in sub-accounts similar to mutual funds which hold assets.
Also, the potential to lose the money invested means more risk is taken with variable deferred annuities. This helps you grow your savings more than any other type of deferred annuity.
- It builds guaranteed future retirement income.
- Investments are created in a way that helps you pick the best approach that fits your goals and risk tolerance.
- It has an advantage when it comes to paying taxes.
- It provides extra benefits when you sign up through contract riders.
- Poor liquidity
- Early withdrawal taxes
- Potentially high fees
- Complicated structure.
How deferred annuity works
Like other annuities, you transfer money to an annuity provider that invests your cash according to the strategy and annuity type you pick. You can make a transfer in huge amounts or smaller amounts over the months or years. Thereafter, you can request payments from your annuity.
A deferred annuity payment can be set for a long period or through your lifetime. This depends on the annuity company that tells you how much you will receive each month.
This amount is dependent on your Val and payment option. However, the longer you set up payments, the lower your payments will be.