The Benefits of a Deferred Annuity
A deferred annuity gives the customer a sum of money at some point in the future. Depending on the contract, the insurance company might pay that sum in a single payment or it could pay out the money over a period of time, such as monthly for 25 years or for the remainder of the customer’s life.
That annuity delivers two key benefits.
1. A guaranteed income.
A customer who chooses to take a deferred monthly payment for the rest of their life will know they’ll have a set amount of money coming to them each month until they die. That makes a deferred annuity a useful supplement to a pension fund.
Pensions alone are rarely enough to live on through retirement years so buying an annuity provides another kind of income that can see someone through their life after work. And if the owner of the annuity dies before receiving payouts, an heir can often inherit the account.
2. Tax deferment.
Annuities have two phases. During the accumulation phase, the customer puts money into their fund. During the payout phase, they receive their returns. The tax on the growth enjoyed by money placed in an annuity is deferred until the payout phase. At that point, the income from an annuity is taxed at the customer’s usual income tax rate.
A deferred annuity, then, functions as a kind of savings plan. It enables people to put money away for the future and know that it’s available when they stop working. But it does come with a number of important caveats.
Annuities Are Tightly Locked
First, annuities aren’t liquid. If you suddenly find yourself with a desperate need for extra cash, tapping into an annuity will be costly. The insurer is likely to demand surrender fees for taking out the funds and the tax authorities will have their own demands if you pull out money before the age of 59.5. They’ll usually want 10 percent on top of the income tax rate. Don’t put your funds in an annuity unless you’re sure that you’re not going to need it until later in life.
Annuities can also be expensive.
The fees that insurance companies charge can be significantly higher for annuities than for other kinds of long-term investments. Those fees vary though, so if you are looking for an annuity, take the time to compare the rates that different insurance companies charge. A small percentage can make a big difference when paid over decades.
And while an heir can inherit a deferred annuity during the accumulation phase, that isn’t always the case for annuities in the payout phase. Without a provision that ensures that the payout continues to an heir following the owner’s death, there is a risk that money saved in an annuity will be lost after just a payment or two.
If you’re combining a deferred annuity with payouts made over a long period, it’s worth looking into a contract’s inheritance provisions to ensure that you’re not just saving for the benefit of the insurance company.