Ensuring your retirement income is sufficient and will offer you peace of mind in those final decades of your life is important.
While individual retirement accounts (IRAs) and 401(k) serve as the most popular and reliable strategies to secure retirement income, these are not your only options. Many people explore various investment opportunities, such as annuities, in order to diversify their financial retirement plans, and there are many benefits to that approach.
What are deferred annuities? How do they work, and what kind of risks do they bear? We answer all of these questions below.
An annuity is an investment product that entails you making a lump sum payment or series of payments in exchange for receiving money later in a lump sum or regular installments, which most people use as retirement income.
A deferred annuity is a type of annuity contract that allows you to structure your retirement income in a specific way. In this case, a saver who enters a deferred annuity contract agrees to have their annuity payments deferred or simply delayed in time.
That is the most substantial difference between deferred annuities and immediate annuities, which offer annuity payments instantly after signing the contract. There is also an option to purchase a split-funded annuity, which combines the benefits of immediate and deferred annuities.
In order to truly understand what deferred annuities are and how they can benefit you, it’s helpful to learn about how they work in practice.
A deferred annuity has two phases:
A saver can decide on receiving deferred annuity payments for a set period of time (for example, 15 years) or for the rest of their life. Of course, this means that the longer your annuity term is, the smaller the annuity installments you can expect. After a consultation with your insurance company, you should have a better idea of how much money per monthly payment you will receive based on different parameters and terms set in your annuity contract.
In most circumstances, there are three main types of deferred annuities that you can consider.
Fixed deferred annuities come with a guaranteed minimum rate of return. What this means is that the insurance company offers you a certain return on investment, lowering the risks you face when purchasing an annuity. Usually, you can expect lower annuity payments with fixed annuities, but it’s a solid option for those who are risk-averse.
A variable annuity is essentially dependent on the performance of investments made by the insurer. When choosing this annuity, your money is being invested in various investment products, like stocks, bonds, or money market accounts.
One considerable advantage of variable annuities is the fact that they offer the potential for a higher rate of return. However, on the flip side, if the investments underperform, you may receive a very small return or even a negative one.
Variable deferred annuities offer a chance to build considerable income payments, but they also come with a fair share of risks, something worth careful consideration when making a decision about this purchase.
The third type, which is fixed indexed deferred annuity, acts as a midway between fixed and variable annuities. This type presents you with a return that is directly tied to a specific market index, such as the S&P 500.
Indexed annuities offer both a minimum rate and a maximum rate of return, so you can benefit from a safety net that fixed annuities bring to the table while still opening the door for some nice returns. For this reason, fixed-indexed annuity contracts are one of the most popular among those who want to minimize their risks and maximize their profits.
We already talked about term deferred annuities, which are bound by a set period, and lifetime deferred annuities, which offer annuity income for the rest of the saver’s life. But let’s take a closer look at these and two other annuity types.
This annuity will be valid for a set period. If you die during its term, the money will be going to people you named your inheritors. After the terms end, you won’t qualify for more payments, even if you’re alive.
As the name itself suggests this type of annuity offers a guaranteed income for the rest of your life. However, unlike a term deferred annuity, a lifetime annuity does not guarantee payments surpassing your death. Even in cases when you haven’t been able to recoup your investment, your family won’t be able to receive the rest of the money from your annuity.
There is an option to get around it by purchasing a dual-life annuity, which basically guarantees your spouse or a person of your choosing the income payments from the annuity after your passing. Another variant of this annuity comes with a death benefit that entitles your heirs to a portion of your annuity’s value following your death.
You can buy a single premium deferred annuity by paying a single lump sum payment for your contract. Often people use funds from their savings accounts, like 401(k), to make such a purchase.
With a flexible premium deferred annuity, you can pay for your contract in smaller, regular installments. This is a valuable option for those who, for example, do not want to use the funds from their retirement plans to finance the annuity.
By making small payments towards your deferred annuity, you are able to build over time a considerable account value, increasing the potential return rates.
As you may know, after this introduction, deferred annuities present some great opportunities for investors, especially for retirees who want to build a stable and diversified retirement financial plan. Still, there are no perfect solutions, so before you make any decisions, it’s worth taking into account all the drawbacks of deferred annuity contracts.
Let’s start with the positives first.
Just like we mentioned before, the best way to learn all about terms, potential benefits, and earnings from your annuity, it’s best to talk to a financial adviser. But if you want to calculate your deferred annuity returns, you can do so by following a rather simple formula.
FV = P * (1 + r/n)^(nt)
In most cases, you’ll be able to withdraw the money from an annuity in three different ways.
You can receive the money from your deferred annuity as a single, taxable lump sum payment.
Many choose to receive the money via systematic withdrawals, which provides the benefit in the form of continuous interest rate growth until the account gets depleted.
Annuitization is similar to systematic withdrawals, as it assumes regular monthly, quarterly, or yearly payments, done in a set period or until the moment you or your spouse dies.
Who should consider purchasing a deferred annuity? If you’re:
This investment product might be for you. You may want to consult your financial advisor or annuity experts in order to determine whether this is something you should consider and what type of annuity best suits your needs.
Hopefully, at the end of this guide, you have a much better idea of what deferred annuity is and what advantages and drawbacks it can offer you. Although the topic of annuities and financial retirement plans can be complex or even daunting, it’s in your best interest to learn about it, so you can make the best choices for yourself and ensure you’re well-equipped to enjoy the last years of your life.
At Annuity Association, we work hard to provide our clients with expert advice on the best annuity products on the market. See our annuities reviews and get the most accurate information from the reliable source.
Contact us today if you have any questions at all. We’re here to help you plan your retirement financial safety net with ease.
Most savers will start to receive annuity payments after reaching retirement age. It’s difficult and, in most cases, quite expensive to withdraw money before that time.
Annuities grow tax-deferred, which means you’re exempted from paying income taxes until the moment money gets withdrawn. When withdrawn, you will need to pay income tax if you purchased the annuity with pre-tax funds, or pay tax on the earnings, if you used post-tax funds to finance the annuity.
Deferred annuities tax benefits allow people to invest their money on much more favorable terms, but it’s crucial to know this is not a completely tax-free investment.
Yes, it’s possible to lose money in a deferred annuity. This pertains to some types of deferred annuities, for example, variable annuities, that are tied to fluctuations in the market.
Jeremiah understood his whole life the importance of community and caring for those who are a part of it. Starting his first business venture at the age of 23, he gained invaluable experience in working with others for a joint purpose.
He founded his first wireless retail business in 2011, expanding it from one store to 12 locations across the state in just three years.
Once he sold his company, Jeremiah began the journey he’s on today, using his talents and experience to work with seniors in order to help them find the best means of financing their retirement plans.
He’s found his true calling working as a proud member of the Annuity Association, assisting retirees in building their safe financial future.