Deferred annuity

Key Takeaways

1. Deferred annuities allow individuals to accumulate savings over time and receive income payments at a later date, typically during retirement.
2. During the accumulation phase, the annuitant makes periodic contributions to the annuity contract, which are invested by the annuity provider to generate returns and grow the value of the annuity.
3. During the distribution phase, the annuitant receives regular income payments from the annuity, which may be guaranteed for a fixed period or for the annuitant’s lifetime, depending on the terms of the contract.

What is a Deferred Annuity

A deferred annuity is a type of annuity contract that defers income payments until a future date, allowing the annuitant to accumulate savings over time and receive a stream of income during retirement or another predetermined period. Unlike immediate annuities, which begin income payments shortly after the annuity is purchased, deferred annuities have a waiting period, known as the deferral period, during which the annuitant makes contributions to the annuity contract.

Importance of Deferred Annuities

Deferred annuities offer several benefits for individuals planning for retirement or other long-term financial goals:

• Retirement savings: Deferred annuities provide individuals with a tax-advantaged way to save for retirement by allowing contributions to grow tax-deferred until distributions are taken, potentially maximizing investment returns over time.
• Income planning: Deferred annuities offer a reliable source of income during retirement, helping individuals supplement other sources of retirement income, such as Social Security benefits, pensions, or retirement savings accounts.
• Financial security: Deferred annuities provide annuitants with a guaranteed stream of income for life or for a specified period, reducing the risk of outliving one’s savings and providing financial security in retirement.

How Deferred Annuities Work

Deferred annuities operate in two main phases: the accumulation phase and the distribution phase:

1. Accumulation phase: During the accumulation phase, the annuitant makes periodic contributions to the annuity contract, either through a single lump-sum payment or through a series of payments over time. These contributions are invested by the annuity provider in a variety of investment options, such as stocks, bonds, or mutual funds, to generate returns and grow the value of the annuity.
2. Distribution phase: During the distribution phase, which typically begins at retirement age, the annuitant begins receiving regular income payments from the annuity. These payments may be fixed or variable and may continue for a specified period, such as 10 or 20 years, or for the annuitant’s lifetime, depending on the terms of the annuity contract.

Examples of Deferred Annuities

Examples of deferred annuities include:

• Fixed deferred annuities: These annuities offer a fixed rate of return on contributions during the accumulation phase, providing annuitants with a predictable stream of income during retirement.
• Variable deferred annuities: These annuities allow annuitants to invest contributions in a variety of investment options, such as stocks, bonds, or mutual funds, offering the potential for higher returns but also greater investment risk.
• Indexed deferred annuities: These annuities provide annuitants with a return based on the performance of an underlying index, such as the S&P 500, offering the potential for higher returns during periods of market growth while protecting against losses during market downturns.

Real-World Application

Deferred annuities are commonly used by individuals and couples as part of their retirement planning strategy:

• Retirement savings: Individuals often use deferred annuities as a tax-efficient way to save for retirement, supplementing other retirement savings vehicles, such as employer-sponsored retirement plans (e.g., 401(k) or 403(b) plans) and individual retirement accounts (IRAs).
• Pension replacement: Deferred annuities can serve as a source of retirement income for individuals who do not have access to traditional pension plans or who wish to supplement their pension benefits with additional income streams.
• Long-term care planning: Deferred annuities with long-term care riders or benefits can provide individuals with a source of income to help cover the costs of long-term care services, such as nursing home care or assisted living facilities, in retirement.