What Is a Deferred Annuity?
Let me tell you directly: a deferred annuity is a contract you make with an insurance company that guarantees you a stream of income or a lump sum in the future. Unlike immediate annuities, which start paying out right away, deferred ones hold off on payments, letting your money grow tax-deferred in the meantime. I'll walk you through the types—fixed, indexed, and variable—and how they can fit into your long-term financial planning.
Key Takeaways
- A deferred annuity is an insurance contract that provides income at a future date after an accumulation period.
- There are three main types of deferred annuities: fixed, indexed, and variable, each offering different methods of return.
- Withdrawals from a deferred annuity before age 59½ may incur a 10% tax penalty in addition to regular income taxes.
- Deferred annuities grow on a tax-deferred basis, which can be advantageous for long-term investment goals.
- Deferred annuities can have high fees and surrender charges, making them less liquid compared to other investments.
Understanding How Deferred Annuities Operate
You need to know there are three basic types of deferred annuities: fixed, indexed, and variable. Fixed ones promise you a specific, guaranteed rate of return on your money. Indexed annuities base their returns on a market index like the S&P 500. Variable annuities depend on the performance of mutual funds or sub-accounts you choose yourself.
All these types grow on a tax-deferred basis. The accumulation phase is when you put money in. When you decide to start getting income, that's the payout phase. Many are set up to pay for the rest of your life, or even your spouse's life too. Just remember, you should have emergency funds ready before buying one, as they're not for quick access.
What Are the Disadvantages of a Deferred Annuity?
Be aware that annuities often come with high fees compared to other retirement options, including surrender charges. They're complex and can be hard to grasp fully. Most contracts limit your withdrawals, maybe to one per year, and you might face those surrender fees from the insurer. If you're under 59½, expect a 10% tax penalty on top of regular income taxes for any withdrawal.
Is an Annuity Considered a Liquid Asset?
Consider deferred annuities as long-term investments. Their liquidity depends on the surrender charges in your contract. During the surrender period, exiting means paying a big fee—say 10% that decreases over time, possibly up to 15 years. That makes them illiquid for most people then. After that period, they're more accessible than selling a house or car, but still less liquid than mutual funds outside an annuity.
What Happens to an Annuity After Death?
Deferred annuities usually include a death benefit. If you die during the accumulation phase, your heirs might get some or all of the account value. But if it's already in the payout phase, the insurer could keep what's left unless your contract specifies ongoing payments to heirs for a set number of years.
Do You Pay Taxes on a Deferred Annuity?
You only pay taxes when you withdraw, take a lump sum, or start receiving income. At that point, it's taxed at your ordinary income rate.
The Bottom Line
Deferred annuities can supplement things like Social Security for retirement income. They provide structured payments but come with complexities. Factor in the high fees and illiquidity when deciding if they suit you. Make sure you have other liquid assets available. Weigh the pros and cons carefully before adding them to your plan.
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