Definition
A deferred annuity is a contract with an insurance company that guarantees income payments at a future date, typically after retirement. The investor makes either a lump sum payment or series of payments into this account, which grows on a tax-deferred basis. Payouts only begin at a specified date, usually when the investor reaches a certain age.
Phonetic
The phonetics for “Deferred Annuity” is: diː-fəːd æ-ˈn(y)o͞o-ə-tē
Key Takeaways
- Accumulation Phase: A deferred annuity offers an accumulation phase where the money you invest grows tax-deferred. This means you won’t pay taxes on your earnings until you start making withdrawals.
- Flexible Payouts: Once the accumulation phase is over, you can choose to receive payouts in a number of ways. You could take a lump-sum payment, set up a fixed payment schedule, or even convert your annuity into a stream of income that you cannot outlive.
- Potential for Penalty: Deferred annuities often come with surrender charges. This means that if you withdraw money during the early years of the annuity contract, you may face a penalty. Therefore, deferred annuities are mainly beneficial for long-term investors who agree to leave their money invested for a significant amount of time.
Importance
The term “Deferred Annuity” holds significant importance in business and finance because it is a key retirement planning tool. It offers tax advantages as the annuity funds accumulate on a tax-deferred basis, which means the interest, dividends, and capital gains remain untaxed until withdrawals begin. Deferred annuities are important for individuals keen on saving for long-term financial goals, particularly retirement. They provide a secure and continuous cash flow for several years, or even for life, post the deferral period. A deferred annuity not only offers investment options but also assures a guaranteed income stream, fostering financial security for the future. Hence, understanding the concept and benefits of a deferred annuity is vital for effective financial planning.
Explanation
The main purpose of a deferred annuity is to provide a steady stream of income during retirement. It is a type of long-term investment typically associated with insurance companies, where an individual makes payments during the accumulation phase (which could last a number of years), with the aim of accumulating a substantial amount of capital. The money you contribute to the deferred annuity grows tax-deferred for a certain period, which means it can grow and compound faster because it’s not being reduced by tax payments. This is particularly beneficial for individuals in high tax brackets looking for an effective way to grow their long-term investments.Deferred annuity is often used as part of a larger retirement strategy by those who seek to secure a constant flow of income in their later years when they stop working. When the annuitization phase kicks off, regular payments are made to the investor, providing a reliable and often tax-efficient income stream. This was designed with the idea that individuals could then rely less on other income sources during retirement, such as Social Security or personal savings. It’s worth noting that deferred annuities can also come with a death benefit feature, providing money to a named beneficiary if the owner dies before income payments start.
Examples
1. Retirement Savings: One of the most common examples of a deferred annuity is a retirement savings plan. An individual might purchase a deferred annuity today, but the payments don’t start until a future date, often after the purchaser has retired. This allows the individual to invest and grow their capital for several years before they start receiving payments.2. Education Funds: A parent might invest in a deferred annuity when their child is young with the aim that the annuity will start paying out when the child reaches college age. The annuity’s deferred status allows it to grow over time, creating potential for higher payout once the child attends college.3. Long-Term Investment: If an individual inherits a sum of money, they might choose to invest it in a deferred annuity. By deferring the payout, the annuity can grow over time. This might be an especially attractive option if the individual does not need immediate access to the funds and wants to preserve and grow them for future needs.
Frequently Asked Questions(FAQ)
What is a deferred annuity?
A deferred annuity is a type of insurance contract that allows you to pile up capital for income generation at a later time. It involves two stages – an accumulation stage, where you make purchase payments, and a payment stage, where the plan is structured to provide payments to you.
What are the benefits of a deferred annuity?
Deferred annuities offer tax-deferred growth. This means you don’t pay taxes on the interest, dividends or capital gains until you withdraw them. They also provide the potential for a stream of income for life.
Can I lose money with a deferred annuity?
The risk in deferred annuities varies depending on whether it’s a variable or fixed annuity. Variable annuities carry market risk and may lose value, while fixed annuities guarantee a minimum rate of return so the principal investment and specified interest rate are safeguarded.
When can I start withdrawing money from my deferred annuity?
Most deferred annuities allow you to start making withdrawals when you reach age 59.5. Withdrawals earlier than this may trigger penalties.
What are the tax implications of deferred annuities?
Drawdowns from deferred annuities are taxed as regular income. Also, if made before age 59.5, they may be subject to a 10% IRS penalty.
Can I pass on the annuity to my heirs?
Yes, the value of your deferred annuity can be passed on to your heirs or a named beneficiary upon your demise. The payouts will continue based on the terms of your contract.
Can I withdraw my money at any time?
You’re generally allowed to withdraw money from your deferred annuity anytime, but withdrawals before age 59.5 may be subject to a 10% early withdrawal penalty.
What is the difference between immediate and deferred annuities?
The foremost difference lies in the payout period. Immediate annuities begin payout at once after purchase, while deferred annuities offer a later payout start date, typically during retirement.
Related Finance Terms
- Accumulation Period
- Annuity Contract
- Guaranteed Income
- Annuitization
- Surrender Charge
Sources for More Information
