What is a deferred annuity?

When you shop for an annuity, one consideration is when you’ll need the income. You can choose an annuity that offers income right away or at a later date. An “immediate” annuity begins payouts within one year. By contrast, with a deferred annuity, you choose a future date to begin getting payments.

A deferred annuity has two main phases:

• The accumulation period is when you’re investing your money. As you pay into the annuity, your account balance grows.
• The payout period comes when you begin receiving money from the annuity.

Another choice you’ll make when buying an annuity: Variable or fixed?

• Variable annuities are linked to a range of investments whose performance will influence your payout. This means variable deferred annuities potentially can provide you with a higher payout later—but they also involve more risk because the value of those underlying investments can rise or fall.
• Fixed annuities are designed for more certainty—they guarantee your principal and a set rate of return. Consider a fixed annuity if you want to feel secure that your retirement income can’t fall below a certain level.

Carefully compare your annuity choices to determine what works best for you.

Choices you can make now to plan for retirement

Think about your goals for life after your career. You’ll likely use a variety of saving and investment tools to prepare. A deferred annuity could be among them, providing protected income during your golden years.

When you buy a deferred annuity, you decide in advance when to start receiving payouts. Usually these payouts are monthly, but you may be able to withdraw on your own schedule. (By contrast, you can choose to begin monthly Social Security benefits—a form of government annuity you pay for via federal FICA taxes throughout your working years— anytime after age 62. The longer you wait to start, through age 70, the bigger your lifetime checks will be.)

You’ll also choose how to receive your annuity income. The main options typically include regular payments for the rest of your life, payments over a set number of years, or a lump sum.

Also, you can choose an annuity that pays money to your spouse or other heirs. This “death benefit” might come in the form of a lump sum or in continued payments.

A later payout date can mean higher payments

If you live a very long time, you may get more money in annuity payments than you paid in premiums. Why? Two reasons:

1. Growth over time. Investment gains and interest potentially can increase your annuity’s value.
2. A decreasing pool of owners. It’s not pleasant to think about, but some people who buy deferred annuities will die before they receive many—or any—payments. In this case, depending on the annuity contract, the insurer may have money left over to distribute to surviving annuity owners. The insurance industry calls these funds “mortality credits.”

Tax treatment of a deferred annuity

If your investment grows during the accumulation phase, the earnings are tax deferred. This means you won’t owe federal income tax on them until you receive payouts. Tax-deferred gains allow your earnings to grow more efficiently. Thanks to compound interest—and more money working for you due to pretax contributions—your balance can grow at a faster rate than if you’d contributed after-tax money. Once the payouts start, they’ll be taxed as ordinary income.

Your heirs may owe federal income tax on annuity payments or a lump sum they receive after your death. (This is different from regular life insurance benefits, which generally aren’t taxable) Even so, taxes on annuity benefits can be complex, so make sure to consult a tax professional.

Is a deferred annuity right for you?

If you expect a long retirement, a deferred annuity may be a valuable tool. Also, the deferred taxes on growth along with guaranteed payments can help you better manage your retirement income.

Questions to ask as you evaluate your situation:

• Will you have enough time for an annuity to grow before you’ll need the money?
• Will you have heirs? Death benefits on deferred annuities can vary depending on the contract and the insurer that provides them. For example, some annuities pay heirs the money left in the account, while others allow you to set a minimum death benefit when you buy. Double-check the details to learn if there’s a death benefit and how much it is.
• How will inflation affect the payouts you’ll receive? Review your annuity’s terms to find out if it’s likely to grow at least as fast as inflation.
• What if you need to withdraw money before you reach retirement age or before the payouts begin? Depending on the terms and when you withdraw, you could be subject to extra costs and penalties.

Written by Miranda Marquit

Miranda Marquit, MBA, has covered personal finance topics for nearly two decades, contributing to outlets including NPR, MarketWatch, Yahoo! Finance, and HuffPost. She also co-hosts a podcast at Money Talks News.

Disclaimer

Prudential annuities are issued by The Prudential Insurance Company of America Newark, NJ, and its affiliates. Variable annuities are distributed by Prudential Annuities Distributors, Inc., Shelton, CT. All are Prudential Financial companies and each is solely responsible for its own financial condition and contractual obligations.

We do not provide tax, accounting, or legal advice. Clients should consult their own independent advisors as to any tax, accounting, or legal statements made herein.

You should consider the features of the contract and the underlying portfolios’ investment objectives, policies, management, risks, charges, and expenses carefully before investing. This and other important information are contained in the prospectus (you can access those for Prudential annuities on the prospectus page or from your local financial professional). Please read the prospectus carefully before investing.

Annuity contracts contain exclusions, limitations, reductions of benefits, and terms for keeping them in force. Your licensed financial professional can provide you with complete details.

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