What is a Deferred Annuity

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A deferred annuity is an investment contract between an investor and an insurance company in which both taxes and the distribution of payments are deferred until a later point in time. Deferred annuities can either be fixed or variable. The rate of return on a deferred fixed annuity is set at a fixed amount, regardless of the performance of a particular index or stock and/or bond mutual funds and money market funds. The rate on a deferred variable annuity is based on the performance of the stock and/or bond mutual funds and money market funds in which the annuitant chooses his or her money to be invested.

How Does a Deferred Annuity Work?

Deferred annuities are classically used as a method of increasing retirement savings. They are structured to provide guaranteed monthly income once the annuitant has retired and instructs the insurance company to “annuitize” the contract, which means to begin making payments. The accumulation phase and the distribution phase are the two parts of a deferred annuity:

The Accumulation Phase

A deferred annuity almost always has an accumulation of principle phase that can last several years. Funding by the investor takes place on a regular basis – monthly, quarterly, semi-annually or annually – and the insurance company invests the deposits for the annuity owner in an attempt to increase the value of the annuity. This is unlike an immediate annuity, which does not have an accumulation phase and is funded with one lump-sum payment.

Distribution Phase

The distribution phase, or payment phase, of a deferred annuity is set to take place sometime in the future. How long in the future and the amount of the payments are specified in the contract. Options exist for the distribution of payments to the owner and his or her spouse, or for payments that continue after the death of the original owner. In addition, a deferred annuity often pays a death benefit should the annuitant or annuitants die before the principal has been returned in the form of payments.

What Are the Different Types of Deferred Annuities?

There are four types of deferred annuities: fixed, variable, indexed and CD. The differences among them are as follows:

Fixed Deferred Annuity

While the accumulation phase is ongoing, a fixed amount of interest, as specified in the contract, is credited to the account. Even though the rate is fixed, it may change from year to year depending on market conditions. An important feature of many fixed deferred annuity contracts is the ability to cancel the contract without penalty if the fixed interest rate of the upcoming term drops well below the rate that was guaranteed at the inception of the contract.

Fixed deferred annuities are considered risk-averse investments that are most suitable for people entering or nearing retirement. But, while there are conditions under which the contract can be cancelled, money placed in this type of annuity should not be considered liquid.

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Variable Deferred Annuity

The interest rate that is paid on a

variable annuity fluctuates based on the return that is achieved by the investments the investor instructs the insurance company to make. The investor can choose among stock and bond mutual funds and money market funds in which to invest the money.

Variable annuities are considered to have higher risk than fixed annuities and are therefore more suited for investors looking for long-term growth. It’s important to remember, however, that money placed in a variable annuity should not be considered liquid.

Indexed Deferred Annuity

An indexed deferred annuity is a hybrid of a fixed and variable annuity. The rate of return paid by the issuer is tied to a financial market index, most often the Standard & Poor’s 500 Composite Stock Price Index (S&P 500). If the index to which the annuity is tied increases in value, the investor more than likely receives a higher rate of return than he or she would with a fixed annuity. If the index decreases, he or she is generally protected from suffering significant losses as most issuers guarantee the principle of an indexed annuity.

Because indexed annuities are tied to the market, they are best suited for investors with moderate risk tolerance.

CD Deferred Annuity

A CD annuity shares some features with a bank CD (certificate of deposit) and is fixed. A CD annuity’s rate is always guaranteed never to fluctuate after the contract is signed. Unlike a bank CD, however, CD annuities are considered longer-term investments.

One of the primary advantages of a deferred annuity is the guaranteed death benefit that is paid to the beneficiary or beneficiaries should the annuitant die before the principle is returned as monthly payments. For example, if an annuitant purchased a $300,000 deferred annuity and had only received monthly income payments totaling $75,000 at the time of his or her death, the beneficiary would receive $225,000. This guarantees that the beneficiary receives the remaining account value, or the amount the original annuitant paid in minus the amount that has been paid out.

What Are the Tax Ramifications of a Deferred Annuity?

Deferred annuities grow tax-deferred. They are not taxed until distributions are taken. When money is withdrawn, only the income portion – not the principle – gets taxed. All annuities are taxed as income, not capital gains.

Who Should Invest In a Deferred Annuity?

A deferred annuity is usually best for the investor who has a long-term accumulation plan in mind. A deferred annuity can also be good for a high net-worth investor or one who has maxed out other tax-free retirement vehicles such as a 401(k) or IRA. They may also appropriate for an investor who wants to guarantee a stream of income for a defined period of time after retirement but not necessarily for the remainder of his or her life.

In addition, small businesses and corporations can benefit from deferred annuities as they can be used to fund pension and retirement plans.

What are the Benefits of a Deferred Annuity?

Investors looking for low-risk and long-term growth may find that over time, a deferred annuity will out-perform several other types of investments. Unlike other investment vehicles, they do not expose an investor to extreme market risk.

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Source: www.freeannuityrates.com

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