Deferred Annuity: What is Deferred Annuity? & How It Works

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To understand the deferred annuity definition, one must know that it is a contract between the investor and an issuer who promises to pay a regular income or a lump sum to the owner at a future date. Many investors use this option to supplement their retirement income during their golden years.

Specifically meant for long-term savings, a deferred annuity does not start paying immediately, unlike an immediate annuity. Investors can delay the payments, and the earnings during this period are tax-deferred. Investors may increase the value by adding money to the account. The best thing is that the investor can withdraw a lump sum whenever needed. Moreover, transferring the annuity plan to another financial institution is also possible.

How Deferred Annuities Work?

Deferred annuities are contracts offering income for a duration in exchange for advance payments. The annuity plan pays out, usually monthly, according to the contract terms, often until the beneficiary’s death. Some annuity plans may also include payouts to the customer’s beneficiaries.

Safety and predictability are the most attractive aspects of this facility. The issuer often offers a specific return on the account or promises a minimum payout. The duration for which the investor invests in the annuity is called the accumulation or savings phase. The time the investor receives income is called the payout or income phase. Many annuity plans provide income for the owner's life and sometimes to their spouse after death.

Types of Deferred Annuities

Deferred annuities differ in terms of their structure. The three major types include the following:

Fixed Deferred Annuities: Fixed annuities have a minimum yield that the issuer guarantees. While the returns may be lower with these annuity types, they have a guaranteed minimum that makes these investments safe for investors with low-risk tolerance.
Variable Deferred Annuities: Variable annuities do not have a guaranteed minimum. The issuer invests the investor’s money in bonds, stocks, and money market accounts, and the returns depend upon the fund’s performance. That means the returns can be higher than fixed annuities if the fund performs well. However, the returns will be small if the investment performs poorly.
Indexed Deferred Annuities: Indexed annuities are a mix of fixed and variable annuities regarding predictability and performance. Their performance depends on a market index like the S&P 500. The better the index performance, the higher the returns. They have a guaranteed minimum plus with a maximum return rate.

Benefits of Deferred Annuity

Now that what is a deferred annuity is clear, it’s important to understand the advantages it offers to the retiree. These include the following:

Tax-Deferred Growth: A deferred annuity allows investors to accumulate wealth within a tax-advantaged account. Investors can save on a tax-deferred basis, which means their account earnings are non-taxable until the payments or withdrawals begin. If the investor uses after-tax money to contribute to the account, the contributions have no extra income tax liabilities.
Guaranteed Income Options: Although low, fixed annuities offer returns guarantee after a pre-determined period. Indexed annuities also offer guaranteed returns but with a maximum return rate permissible. Variable annuities have returns based on fund performance, making them riskier but with a high return potential.
Potential for Investment Growth: With a delayed payout, deferred annuities give money more time to grow through compounding. As a result, the payout increases. The longer the deferment period, the higher the payout.

Conclusion

A deferred annuity is a lucrative investment option for those seeking a reliable and safe income post-retirement. Apart from the flexibility in choosing how and when to receive the income, these plans offer guaranteed returns with minimal risk. These plans are perfect for people with some years left for retirement and do not require money immediately. However, those seeking immediate income should opt for an immediate annuity plan. Therefore, carefully considering retirement goals and needs is crucial before deciding on the right annuity plan.

Frequently Asked Questions

What is the difference between a deferred annuity and an immediate annuity?

The major difference between deferred and immediate annuities is the timing of payouts. In an immediate annuity plan, income starts immediately after investment. However, payouts start when the deferment period ends in a deferred annuity scheme.

How are earnings taxed in a deferred annuity?

A deferred annuity offers tax benefits under Section 80C of The Income Tax Act 1961, and the premium payments are tax-deductible under Section 80C.

Can you withdraw money from a deferred annuity?

Withdrawing money from deferred annuities is allowed, but the investor must pay a tax penalty and surrender charges.

What happens to a deferred annuity upon the death of the annuitant?

If the investor dies before the beginning of the annuity, the beneficiary receives a lump sum. If the annuitant dies afterwards, the beneficiary continues receiving the payments. If no beneficiary exists, the remaining fund is surrendered to the financial institution.

What Is a Deferred Annuity?

How Deferred Annuities Work?

Types of Deferred Annuities

Benefits of Deferred Annuity

Conclusion

Frequently Asked Questions

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