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What is a deferred annuity?

What is a deferred annuity?A deferred annuity is a financial product that provides regular payments over time, but the start date for the payments does not start immediately. The individual buying the annuity can choose to deposit funds into the plan on a lump-sum basis, or contribute to it on a regular basis over a number of years.

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Learn about the accumulation and distribution process of deferred annuities, and the various annuities available before making a decision. The type of annuity you select is dependent on your needs.

Accumulation and Distribution

The deferred annuity is made up of two phases: accumulation and distribution. The accumulation phase is the time when the purchaser makes contributions to the annuity plan. This may be deposited in the form of a lump sum or on a monthly basis over a number of years.

When the funds are received by the insurance company, they are invested on behalf of the purchaser and earn interest.

The money held within the annuity grows on a tax-free basis until the funds are withdrawn. Up to 10% of the money may be withdrawn without the annuitant being charged a penalty, but the money will be subject to income tax as of the date of withdrawal.

The distribution phase of the plan is where the money held in the annuity is paid out. The specifics about the amount and frequency of the payments are set out in the annuity contract.

Types of Annuities

A person who is interested in buying an annuity has a number of options available for types of annuities. They can choose from a fixed, variable or an indexed type.

  • A fixed deferred annuity¬†offers the investor a set rate of return on the funds invested in the plan. The amount of guaranteed interest may be set on an annual basis, depending on the plan. This type of plan usually has some type of bail-out clause, so that an annuitant can withdraw his or her funds if the guaranteed rate of return offered is below a certain level. The fixed deferred annuity is considered a conservative investment and is recommended for people who are at or close to retirement age.
  • A variable deferred annuity¬†allows the purchaser to choose where his or her money will be invested instead of leaving this decision up to the insurance company. He or she can select mutual funds, bonds or money market funds for this purpose. Since the rate of return for this type of annuity depends on market conditions, it is considered a riskier investment than a fixed deferred annuity.
  • An indexed deferred annuity offers a rate of return that is tied to an equity index, such as the Standard and Poor’s 500. This option offers a better rate of return during times when the market is performing well.

To protect investors during times when the market is down, an indexed deferred annuity offers a minimum guaranteed return on the investment. This option offers an investor the potential for a higher rate of return if market conditions are favorable, but also lowers the risk if the markets are not performing as well.

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Choosing an Insurance Company

If a consumer has decided that a deferred annuity is a good choice for his or her retirement plan, he or she should consider the insurance company that will hold the funds very carefully. This is a long-term investment plan and the insurer that is selected will be managing the annuitant’s money for a number of years. It’s very important to choose an insurance company that is well established and that is financially sound.

Before choosing an insurer, a consumer should check out the company with one of the financial ratings agencies. Moody’s and Standard and Poor’s are two examples of agencies that rate insurance companies. A person interested in buying an annuity should invest with an insurer that has an “A” rating, which indicates that it is being well run and is not likely to have difficulty meeting its financial obligations.

People who buy annuities may have some protection against the insurance company going bankrupt from a state-run plan, but the benefits available are limited. If someone has a substantial amount of funds to invest, they may wish to consider buying more than one annuity to lower their risk instead of placing all of their investment funds in one basket.

A deferred annuity is one where the funds are invested with an insurance company but there is delay before the funds are distributed. This type of plan allows an annuitant to deposit a lump sum into the annuity or make regular deposits (for years in some cases) to save money for retirement.

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