What is a Deferred Annuity?

Annuities are a versatile financial tool that can be used to ensure that retirees do not outlive their income. There are numerous decisions that an annuitant must make when purchasing his or her annuity. One of these decisions is whether or not the annuitant would rather begin to receive payouts immediately or delay the payouts until a future date. This article will highlight the latter option, which is known as a deferred annuity. 

What is a Deferred Annuity?

A deferred annuity is a type of annuity under which the annuitant invests their principal and then delays the payouts for a period of time that is specified in the annuity contract. The annuitant decides exactly when he or she wants to start receiving their payouts. Deferred annuities can be funded by the annuitant over time through a series of payments, or more commonly with one lump sum payment upfront.

Deferred annuities include 2 phases in their process. Once the annuitant has funded the account, the annuity immediately enters the first phase, known as the accumulation phase. The accumulation phase is the period of time after the annuitant has purchased the annuity, but before he or she starts to receive payouts. During the accumulation phase, the invested principal sits in the annuity and accrues interest. The accumulation phase generally lasts five years or more. This accumulation phase is beneficial to the annuitant because it allows their money to grow over time, and therefore receive larger payouts in the future and as a result allows them to make a smaller upfront investment than necessary with an immediate annuity.

Eventually, the annuity enters the second phase which is called the payout phase. The beginning of the payout phase is specified in the annuity contract and will be a number of years down the road from when the premium payment is made. The payouts can be made for a chosen length of time or for the remainder of the annuitant’s life. Like immediate annuities, deferred annuities allow the annuitant to decide how frequently he or she wants to receive payments, whether that is monthly, quarterly or yearly. Also similar to immediate annuities, deferred annuities offer flexible payout options such as making it a joint annuity, cash refund options, and guaranteed payments to your beneficiaries for a specified length of time.

Example of a Deferred Annuity

Mike, a 50-year-old man, opens a deferred annuity account with a lump-sum premium payment of $100,000. His principal investment of $100,000 grows in his account for the next 15 years, and he has access to her annuity payouts beginning when he is 65 years old. Over the course of the 15 years, his initial investment grows at an annual interest rate of 3.5%, and his annuity is worth $167,535 by the time he is 65 years old. When Mike turns 65, he begins to receive monthly payouts from his annuity that are set to continue for the remainder of his life. His payouts are the same amount each month, $785. 

Advantages of Purchasing a Deferred Annuity: 

• Deferred annuities are cheaper to buy upfront than immediate annuities, and they enable the annuitant to choose the specific date at which it will be ideal for them to start receiving payouts. 
• Deferred annuities allow the money in the account to grow during the period of time that the payments are being delayed. The money in the annuity will accumulate earnings in a tax-deferred manner, and the original investment may grow substantially over time, which will result in larger payouts to the annuitant when the payout period begins. Giving the original principal the opportunity to grow in the accumulation period means that deferred annuities offer significantly higher payouts than an immediate annuity for the same upfront cash investment

Disadvantages of Owning a Deferred Annuity: 

• The most obvious drawback of owning a deferred annuity is the fact that the payouts are delayed. If the annuitant wants access to their money before the payout phase begins, he or she will be hit with a surrender charge in order to withdraw money from the account. 

The Bottom Line

Deferred annuities can be useful in multiple situations. Deferred annuities generally appeal to those who want the security of having guaranteed income in the future, and are not in need of a steady stream of income right now. Deferred annuities are best for people who are planning ahead and wish to have the peace of mind that he or she will have reliable income in the future. Deferred annuities are a unique option that potential annuitants should explore, however it is important to consider other annuity variations. 

Special thanks in preparing this summary of “What is a Deferred Annuity?” goes to Bob Carlson, leader of the Retirement Watch advisory service and chairman of the Board of Trustees of Virginia’s Fairfax County Employees’ Retirement System with more than $4 billion in assets.