Our featured article of the month, Immediate vs. Deferred Annuities explains some of the basic differences between these long used retirement vehicles. In the past few decades, pensions have become few and far between, especially within the private sector. Having similar traits, annuities have secured a consistent presence in the retirement planning industry. The reason? Likely the predicability of the outcome.
Pensions provide a monthly income based on units earned over a career, which can help secure a retirement income plan. Annuities can provide a similar result. An immediate annuity is an insurance company backed contract that provides an agreed upon monthly income based on the amount of the intial premium and the expected longevity of the owner/annuitant. Additionally, the options chosen by the owner will affect the payout too.
Immediate annuities are prudent options for a retiree looking to protect both themselves and a loved one by providing monthly income lasting until death. They secure a baseline of income for not just financial security but for piece of mind. The premium committed initially, will result in income being paid out immediately. If income is not desired right away, the income could be deferred to some point in the future by utilizing a deferred annuity.
A deferred annuity can be setup in a very similar fashion as the immediate annuity with one glaring and significant difference; time. A deferred annuity is meant to defer the agreed upon income until some future date. Why would that be a consideration? Maybe a pre-retiree is five years away from retirement and needs to catch up on their savings to secure the retirement lifestyle they desire. Or they are in receipt of a large sum of money, are in a high tax bracket right now and wish to tuck it away for a future retirement. A premium payment to a deferred annuity offered by an insurance company could be a prudent choice for similar benefits of the immediate annuity, but coemmencing a few years into the future.
To dive further into understanding lifetime annuity payouts, click here to read an article by Investopedia.
Despite not being as well known as some other retirement tools, annuities account for 6.5% of all assets earmarked for retirement. With about $2.2 trillion in assets, annuities hold more funds than Roth IRAs.1
An annuity is a contract with an insurance company. In exchange for a premium or a series of premiums, the insurance company agrees to make regular payments to the contract holder. The funds held in an annuity contract accumulate tax deferred.
For individuals interested in accumulating retirement assets, annuities can be attractive because they are not subject to contribution limits, unlike most other tax-deferred vehicles. In other words, retirement-minded individuals can set aside as much money as they would like into an annuity.
Two Phases
Annuity contracts pass through two distinct phases: accumulation and payout. During the accumulation phase, the funds accumulate until the annuity contract reaches its payout date. At that time, the total will either be paid out as a lump sum or as a series of payments over a period that can stretch as long as the account holder’s life.
The funds attributed to the initial premium will not be taxed, but any earnings on those funds will be taxed as regular income.
Immediate Annuity
As its name implies, an immediate annuity is structured to provide current income. After paying the initial premium, an individual receives regular income, which can be deferred for up to twelve months. The funds remaining in the contract accumulate on a tax-deferred basis. Only that portion of each payment attributable to interest is subject to taxes; the rest is treated as a return of principal.
Deferred Annuity
It is also possible to purchase an annuity contract that defers payout until a specific date in the future. The premiums you pay to a deferred annuity accumulate and earn interest during the accumulation phase. The annuity holder determines the amount of payments and when the payouts begin, which is usually in retirement. With a deferred annuity, the earnings credited to your contract are taxed when they are withdrawn.
Annuities have contract limitations, fees, and charges, including account and administrative fees, underlying investment management fees, mortality and expense fees, and charges for optional benefits. Most annuities have surrender fees that are usually highest if you take out the money in the initial years of the annuity contract. Withdrawals and income payments are taxed as ordinary income. If a withdrawal is made prior to age 59½, a 10% federal income tax penalty may apply (unless an exception applies). The guarantees of an annuity contract depend on the issuing company’s claims-paying ability. Annuities are not guaranteed by the FDIC or any other government agency.
For retirement-minded investors, annuities have some attractive features that may be worth exploring. Annuities also have certain limitations and expenses that need to be considered before committing to a contract.
This article is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your tax, legal, and accounting professionals before modifying your tax strategy.
Variable annuities are sold by prospectus, which contains detailed information about investment objectives and risks, as well as charges and expenses. You are encouraged to read the prospectus carefully before you invest or send money to buy a variable annuity contract. The prospectus is available from the insurance company or from your financial professional. Variable annuity subaccounts will fluctuate in value based on market conditions and may be worth more or less than the original amount invested if the annuity is surrendered.
1. ICI.org, 2024
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