Deferred Annuity Definition
Deferred annuities are purchased with after-tax dollars and allow the money to grow tax-deferred. This means that deferred annuities do not have any taxes taken from the annual income it generates. After a period of time, usually, when you retire, you can start taking periodic payments from the deferred annuity in a manner similar to a 401(k) plan.
How Does It Work?
When deferred annuities are purchased with after-tax dollars, the money you initially invest is not taxed on any of the earnings of the deferred annuity. Further, there are no required withdrawals during your lifetime, which allows your money to continue to grow tax-deferred.
To buy a deferred annuity, you invest money into the deferred annuity. This is known as the premium payment. The deferred annuity will then hold onto your money until a future date when you can begin to withdraw funds from it.
When you are ready to begin withdrawing funds, this is called the deferred annuity payout period. At this point, you can begin receiving periodic payments from the deferred annuity. Many deferred annuities will offer choices on how the money is distributed to you each year. This is known as an option that can be selected during the deferred annuity payout period.
Types of Deferred Annuities
There are many types of deferred annuities, and each deferred annuity is different. However, deferred annuities do have some things in common. The most important thing deferred annuities have in common is that they allow for your money to grow tax-deferred while it remains inside the deferred annuity.
The deferred annuity that provides an investment in fixed interest securities is known as a fixed deferred annuity. You receive periodic payments from these deferred annuities each year.
These payments are determined by the interest rate you select when purchasing the deferred annuity. As your deferred earnings accumulate, they will be invested in bond funds or money market accounts.
The deferred annuity that allows you to invest in a more diversified pool of assets is known as a variable deferred annuity. These deferred annuities allow you to invest your money in individual stocks, bond funds, mutual funds, and other securities.
The deferred earnings on this type of deferred annuity are either credited with the actual appreciation of the securities or credited with a fixed interest rate.
The deferred annuity then pays you the deferred earnings either once you reach age 59 ½, if you have already retired, or when you begin taking periodic payouts from your deferred annuity.
The deferred annuity that mimics the growth of a financial market index or an index fund is known as an indexed deferred annuity. These deferred annuities may follow a stock market index, a group of stocks, or a foreign currency.
The deferred earnings on this type of deferred annuity are either credited with the actual appreciation of the index or credited with a fixed interest rate.
Pros & Cons of Different Types of Annuities
Fixed Deferred Annuity
This type of deferred annuity is an excellent way to grow your money tax-deferred while investing in fixed interest securities. The returns that you can receive on this deferred annuity are usually guaranteed by the insurance company, making it one of the most secure investments around.
Additionally, you can usually receive a higher return on this deferred annuity when compared with a bank CD.
These deferred annuities have a minimum that needs to be contributed in order for the contract to kick in.
In addition, the deferred earnings are not guaranteed and depend on the interest rate selected when purchasing this deferred annuity.
Variable Deferred Annuity
This deferred annuity gives you the opportunity to invest your money in a more diversified pool of assets, which provides for a more stable return on your deferred earnings.
The deferred earnings on this type of deferred annuities are either credited with the actual appreciation of the securities or credited with a fixed interest rate.
The deferred earnings on this deferred annuity are either credited with the actual appreciation of the securities or credited with a fixed interest rate.
This means that if these deferred annuities do not perform well, your deferred gains may be reduced each year until you eventually realize that you have lost some deferred earnings.
Index Deferred Annuity
This deferred annuity follows an index, which allows you to receive the gains of that index minus any fees associated with owning this deferred annuity. This deferred annuity often provides for higher returns than fixed deferred annuities and is usually less volatile than variable deferred annuities.
Some deferred annuities that track an index usually have a cap on the number of deferred gains that you will receive each year.
In addition, these deferred annuities often carry higher fees than other deferred annuities.
Why Should You Consider a Deferred Annuity?
A deferred annuity is a great way for you to grow tax-deferred and continue to save for your retirement. The deferred annuity allows you to maximize the amount of money you are able to set aside, while potentially reducing the amount of taxes that you pay on this deferred income.
A deferred annuity is also a good way for seniors who are currently retired to supplement their current savings using after-tax dollars. Once an annuity is purchased, it works like a savings account. You can make deferred contributions from year to year and watch your money grow tax-deferred.
The Bottom Line
A deferred annuity is a great way to supplement your current savings and provides you with greater flexibility than other investments. These deferred annuities also allow you to grow your deferred earnings tax-deferred, which can come in handy for those who are currently retired or approaching retirement.
These deferred annuities are one of the best ways to grow your money tax-deferred. If you are looking for a good retirement savings tool, deferred annuities are the way to go.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.