Deferred annuity

Definition

A deferred annuity is a financial product that allows an individual to invest money and accumulate funds over a specified period before receiving regular payments, typically during retirement. This type of annuity offers tax-deferred growth on the investment, meaning taxes are not paid on earnings until they are withdrawn. The funds are generally paid out in the form of periodic payments after the accumulation phase ends, providing financial security during retirement.

5 Must Know Facts For Your Next Test

1. Deferred annuities can be funded with either a lump sum payment or through a series of contributions over time.
2. They provide tax advantages, as earnings grow tax-deferred until withdrawals begin, allowing for potentially greater accumulation of funds.
3. There are two main types of deferred annuities: fixed and variable; fixed provides guaranteed returns while variable allows for investment in various portfolios.
4. The length of the accumulation phase can vary significantly depending on individual goals, with some people choosing several years while others may opt for decades.
5. Many deferred annuities come with surrender charges if the investor withdraws funds before a certain period, so it’s important to understand the terms before committing.

Review Questions

• How does a deferred annuity differ from an immediate annuity in terms of payment schedules and tax implications?
  • A deferred annuity differs from an immediate annuity primarily in its payment schedule; while immediate annuities start paying out almost right after the investment, deferred annuities have an accumulation phase where funds grow over time before payments begin. Additionally, both types offer tax benefits, but with deferred annuities, taxes on earnings are deferred until the payouts are received, allowing the investment to potentially grow larger due to compounding interest during the accumulation phase.
• Discuss the benefits and risks associated with investing in a deferred annuity, particularly focusing on its tax advantages and liquidity constraints.
  • Investing in a deferred annuity offers several benefits, including tax-deferred growth, which allows individuals to save more effectively for retirement without immediate tax burdens. However, there are also risks, particularly regarding liquidity; many deferred annuities impose surrender charges for early withdrawals, which can limit access to funds in emergencies. Understanding these aspects is crucial for individuals considering a deferred annuity as part of their retirement strategy.
• Evaluate the impact of interest rate fluctuations on both fixed and variable deferred annuities and how they influence investor decisions.
  • Interest rate fluctuations significantly affect fixed and variable deferred annuities. In a low-interest-rate environment, fixed deferred annuities may offer lower returns than expected, prompting investors to seek higher-yielding options like variable deferred annuities, which are tied to market performance. As rates rise, fixed options might become more appealing again. Investors must consider their risk tolerance and market conditions when deciding between these types of deferred annuities, balancing safety and growth potential according to their financial goals.

Related terms

Immediate Annuity: An immediate annuity starts paying out income almost immediately after the initial investment is made, unlike a deferred annuity which has an accumulation phase.

Accumulation Phase: The accumulation phase is the period during which the investor contributes money to the deferred annuity and earns interest on that investment before payouts begin.

Payout Phase: The payout phase refers to the period when the deferred annuity begins making regular distributions to the annuitant, providing income for a set duration or for life.