What Is the Difference Between Immediate and Deferred Annuities?
Annuities are a growing option for retirees looking for relatively ‘worry-free’ places where they can place their money without too much stress. There are many different types of annuities. But all annuities can fundamentally be divided into two main categories: immediate and deferred annuities.
By definition, an annuity is when someone puts a single lump-sum payment or a series of payments into a contract offered by a life insurance carrier. At a later point, this person starts receiving a stream of income from the annuity contract. The income stream can be for either a set period or the rest of their life.
So, what are the key differences between a deferred and immediate annuity? Here’s a quick look at the overarching distinctions.
How Do Immediate Annuities Work?
Depending on when you need income from an annuity, you might buy an “immediate” annuity or “deferred” annuity contract. Immediate annuities are also known more formally as “single premium immediate annuities.” Many people refer to them as SPIAs for short.
As the name of an immediate annuity suggests, your income payouts start right away. At the latest, the payments will start 12 months after your annuity purchase date. Once your income starts, you will receive a regular check that is always for the same amount.
How Does an Immediate Annuity Pay You Income?
Depending on how long you need income, you can receive checks for 5 years, 10 years, or 20 years. You could even opt to receive annuity income payouts for the rest of your life. You can also designate that payments continue to your spouse should you pass away.
When you begin your income payments from an immediate annuity, you can’t reverse your decision. It’s unchangeable.
The premium that you paid into your SPIA policy was converted into a series of payments for whatever timespan you chose. Once the payments begin, this schedule becomes set in stone. It can no longer be altered.
What’s more, because the payments start right away, there is no period for your lump sum in an immediate annuity to be credited interest. This irreversible process of converting your lump-sum premium to a series of payments over time is called “annuitization.”
How Do Deferred Annuities Work?
Unlike an immediate annuity, a deferred annuity has a “waiting period” before its payouts start.
The income payments from a deferred annuity contract usually start in the contract owner’s later years, such as after age 59.5. The waiting period can be as short as two years or as long as decades from when you buy the contract.
As the deferred annuity’s name implies, there is a “deferral” or ‘waiting’ period before you start the income. During this period, your annuity’s contract value earns interest.
How Will Your Money Grow in a Deferred Annuity?
In a fixed deferred annuity, that interest will be a preset, guaranteed fixed rate. In a fixed deferred index annuity, you can earn interest based on an underlying index benchmark.
For many fixed index annuities, the underlying benchmark is the S&P 500 price index. When the index goes up, your money earns interest based on a portion of that increase.
If the index goes down, your principal and interest earnings are locked in. Your contract value will be credited with zero interest for that period of index losses.
But the current value of the contract won’t decline due to the benchmark drop. Furthermore, when the next crediting period begins, the benchmark index may start to recover and increase in value once again.
You will be credited with all of the “rebound” growth in the benchmark. You won’t have to wait for the benchmark to reach its previous high before you can earn any interest.
For example, say you use a one-year crediting period and have the S&P 500 for your benchmark. Then the index drops from 1,200 to 900 during the first crediting period. You simply earn zero percent for that first period.
When the next crediting period begins, your interest earnings will be calculated with 900 as the starting value. You don’t have to wait for the index to go back to 1,200 in order to earn any interest.
Deferred Annuities Often Give More Flexibility
Also unlike with a SPIA, a deferred annuity gives you more options for keeping control of your money. You can tell the insurance company when to start your payouts.
Unless, that is, you hold out until the age when required minimum distributions begin. If you bought your annuity with pre-tax qualified money from an employer retirement plan or a traditional IRA, Uncle Sam will want his share at this point.
Some insurance companies may require you to start income payments at this age so you satisfy your RMD requirements. Otherwise, annuity owners have quite a bit of flexibility of when their income starts.
What Options Do You Have with a Deferred Annuity?
You have the option to annuitize your lump sum in a deferred contract into a stream of payments (just like an immediate annuity does). But this isn’t a forced option like in an immediate annuity.
Most policyholders choose to buy a fixed deferred annuity with an income rider. This income rider benefit them receive a guaranteed lifetime income and keep some control of their money.
You might also have some ability to turn those income payments on and off at will, so long as certain requirements are met.
It’s also good to keep in mind that in some annuity contracts, the income rider benefit comes at an additional charge. Ask your financial professional for details in any deferred contracts you may be considering.
Alternatively, you can simply take a systematic withdrawal from the contract that you can also start, stop, or change at will as you need to.
This system withdrawal option doesn’t provide a lifetime income guarantee. But it’s one of the most flexible options available for receiving income from a deferred annuity contract.
What Situations is an Immediate Annuity Strong in?
Despite their rigidity, immediate annuities can be a good choice for people who need income now. They are worth a look-over if someone wants higher returns in their lifetime income than they can get from other guaranteed instruments such as CDs, Treasury securities, or savings bonds.
But keep this in mind, however. Any distributions from an annuity that are received before age 59.5 will be subject to a 10% early withdrawal penalty by the IRS.
Another Difference Between Deferred and Immediate Annuities
While they are built for income, deferred annuities also double as retirement-savings vehicles. The money that is inside them grows tax-deferred until the annuity owner retires and starts drawing income.
This is true regardless of whether the annuity is a fixed, fixed indexed, or variable contract.
While not commonplace, both deferred and immediate annuities can be in employer-sponsored retirement plans. You can also seek guidance from an independent financial professional, who has access to numerous insurance companies instead of just a set menu, for more potential solutions.
Compare Annuity Options from Multiple Carriers
If you want more options from multiple companies – and that is definitely to the good to explore your choices – an independent financial professional can walk you through multiple annuity contract selections.
That can help you in making the most of your time in exploring the differences between various annuity contracts as well as guaranteed annuity payouts. Consult your financial advisor for more information about annuities and how they can benefit you.
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