We hope you find this article helpful.
If you want Safe Wealth Plan to assist you with your safe wealth strategy, click here.

What is a Deferred Annuity and How Does it Work?

In this article

A deferred annuity is a contract with an insurance company that’s designed to generate income for retirement. The main difference between a deferred annuity and an immediate annuity is that while the latter starts monthly or annual payments immediately, with a deferred annuity investors have the option to delay payments indefinitely. 

During this time, any earnings that are in the account are tax-deferred. A deferred annuity is funded by either a large payment one time or smaller payments that are made over the years or months. This is an option that many investors opt to use since it gives them more flexibility and they can grow in this period. 

Typically investors will use deferred annuities to supplement their other retirement income. The reason that many investors are quick to choose a deferred annuity is that it will help them out in a few different ways; not only are they building up their retirement fund but they’re also going to be generating income once they get there. 

If you’re wondering if a deferred annuity contract is for you and all the smaller details that you want to be aware of, we’ll share them in this article. We’ll walk you through how they work, the different types, and if it might be something you want to go forward with. 

How A Deferred Annuity Works 

Before you can understand exactly how a deferred annuity works you need to understand the basics of how annuities work. Although it may sound complicated, the basic idea and structure for annuities are simple to grasp once you look at them. An annuity is a contract that is usually drawn up with an insurance company. The insurance company will offer income for a time in exchange for being given money. Usually, these annuities will payout, depending on the specific terms of the contract, until the investor dies. 

The reason that many investors opt to choose a deferred annuity is that it’s a reassuring safety measure that they can take. Many times the insurance company will offer an aspect of security to the investor by guaranteeing a minimum payout value or return on their account. When you decide that you want to purchase an annuity and start receiving payments within a year then it’s an immediate annuity. 

It turns into a deferred annuity when you decide to wait to collect payments. Investors may opt to contribute smaller payments throughout their working lives, simply adding smaller amounts and bigger sums if they’re able to. The main difference to note between immediate annuities and deferred annuities is that with the latter the investor is agreeing to receive their benefit later, most times years later. With an immediate annuity, the investor will agree to deposit a lump sum, and then they’ll start receiving benefits right away. 

Different Types Of Deferred Annuities 

If you’re thinking about choosing a deferred annuity then it’s important to know that there are a few different types to choose from. Each of these is different and depending on which annuity you choose it’ll affect your future and your annuity income. You want to make sure to thoroughly do your research so that you know exactly how it’ll affect your income, your retirement, and the payments that you make. Deciding which annuity is the best option for you depends on your investment goals and what you need. 

Fixed Deferred Annuities 

Fixed annuities have a minimum yield that’s guaranteed by the insurance company. The downside to this type of annuity is that typically the return can be lower than other types of annuities. Since the guaranteed minimum is lower for fixed deferred annuities it’s typically a better investment for those with lower risk tolerance. It’s also important to keep in mind that fixed rates do not come with inflation protection.

Index Deferred Annuities 

The next type of annuity is an indexed deferred annuity and the most complicated one. The reason is that the performance of indexed rates is dependent on a market index. Market indexes such as the S&P 500 are tied to the index investments which means that the better it performs, then the better the returns that you’ll get from the index deferred annuity will be. 

When the market is doing well, you’ll earn more money and when it doesn’t do well, you’ll make less money. Although there’s a fair amount that’s unpredictable when it comes to index deferred annuities, there’s also some stability. Indexed rates set a guaranteed minimum rate and a maximum rate of return. 

Variable Deferred Annuities 

A variable annuity has no guaranteed rate of return. Unlike the previous annuities mentioned above, there’s no minimum rate of return. Investors will invest their money into sub accounts where assets like bonds, stocks, and money market accounts are held. Your investment increase will depend on how well the investments that you choose do. If the investments that you’ve chosen don’t do well then your earnings will decrease and if they do well then you’ll earn money. 

This type of annuity is by far the riskiest out of all the options, but there’s also more potential when you choose this type of annuity. With this, you have the potential to grow your savings more than you could with the other types of annuities. You must look at your investments and savings and decide if it’s worth the risk to choose a variable annuity or a different option based on what you need. 

Benefits Of A Deferred Annuity 

When you’re thinking about which is the best option for you and what you should choose based on your current needs, you want to think about the benefits of choosing a deferred annuity. There are quite a few different benefits to choosing a deferred annuity and depending on your current situation and investments, you want to make sure that you look at all the pros and cons so that you know you’re making the best possible choice when it comes to a deferred annuity. 

Although there are many benefits to choosing a deferred annuity, here are just a few of the top ones that will help you decide if a deferred annuity is for you. 

There Are Extra Rider Benefits 

If you choose a deferred annuity there’s the option to purchase extra benefits. You can do this through contract riders and you can choose from a variety of benefits. Once you decide to go with a deferred annuity you can assess the extra rider benefits that come with it and which ones are worth investing in. 

There Is No Contribution Maximum 

With a deferred annuity, there’s no limit on how much you can save per year. This is one of the biggest benefits of choosing a deferred annuity since you’re free to save as much as you like each year unlike retirement funds like 401(k) that set limits on how much you can save. When you’re thinking about whether a deferred annuity is for you, make sure to see how the limits compareto similar options. 

Flexibility With Investments 

Perhaps the most significant benefit of all is that you have such a broad range of benefits when it comes to your investment options. Since deferred annuities have so many different types you get to choose an approach that works best for you and your goals. 

You can examine your risk tolerance, look at your investments and your goals and see which fits you best depending on these. This is one of the biggest reasons why people opt to use deferred annuities because they know that they’ll have the most flexibility with their investments and that they have multiple types to choose from. 

Get Started

Annuities can be a bit confusing, which is why it is always recommended to speak with a qualified professional. Reach out to us and we’ll get you connected with a qualified annuity pro.

Download Our FREE Safe Wealth Guides

Need help?
Schedule a consultation with a Safe Wealth Plan Agent today

Subscribe to updates

About the Author: Benjamin Hulburt

Benjamin Hulburt - Safe Wealth Plan