Deferred Annuities – Know the Basics

Saving for retirement is imperative during the working years of an individual and it is wise to invest the savings where it can enjoy tax deferred growth. In this respect, fixed deferred annuity is worth considering after making the maximum possible contribution to 401(k) and IRA. Money can be invested in fixed deferred annuities without fearing about losing the principal amount invested.

Deferred annuities is a type of contract where the investor (called annuitant) keeps making contributions to his annuity account with an insurance company which pays him back during his retirement. The insurance company will give predetermined interest on this contribution that is usually higher than CDs. Thus, this contract has two phases:

  • Contribution phase: In this phase, the annuitant can keep on contributing to his annuity account. Here the most attractive aspect is that the contribution and earnings are exempt from taxation until withdrawal. During this stage, money paid by you (called premium) will earn interest at the rate decided by the insurance company and this rate varies among different insurers. Further, the insurer may vary this interest rate from time to time. Some insurers change the interest rate once in few years, say 3 or 5, and some insurers may credit different interest rate for each premium. But the insurance company will give you the guarantee that the interest rate will never fall below the minimum guaranteed interest rate stated in the agreement. The interest rate changes are entirely up to the insurance company.
  • Withdrawal phase: Once the annuitant becomes 59 ½ years old, he can then choose to take the money out without incurring any penalty. He may opt to take the withdrawal either in one lump sum or he can convert it into an immediate annuity where the insurer guarantees the regular cash flow to the annuitant. i.e., a deferred annuity can be exchanged, on a tax-free basis, for an immediate annuity. Various payment options are available with immediate annuities.

Features:

  1. No limit: There are no limits on an individual’s contribution to the annuity.
  2. Tax sheltering: As the annuitant contributes his pretax money to the insurer, his taxable income will get reduced during his working years. Further, earnings on investment will grow tax deferred until he starts taking withdrawal. This is an important feature of deferred annuities as the young investors who contribute to the annuity can enjoy tax free compounding on their investments for many years.
  3. Death benefits: In the event of annuitant’s death, the beneficiary will get the policy’s cash value.

Unlike stock market, the fixed deferred annuity is suitable for people who are conservative and prefer to invest their money in risk free products. It provides the guarantee of principal along with the fixed interest rate and enjoys tax deferred growth. Those who does not want to dance to the music of wall street can opt for fixed deferred annuity where their money will grow steadily without being exposed to the risks of market volatility.

Deferred annuity is essentially a vehicle to accumulate funds and turn them into a reliable source of income during retirement. It can be used to enhance your retirement savings once you max out your contributions to 401(k) and IRA. If you fear that you may outlive your retirement nest egg and wants to build a source of income on which you can rely on during your golden years, then you can purchase a fixed deferred annuity and, when you retire, you can convert it into an immediate annuity.

That is why, it is said, fixed deferred annuity is suitable for those who have long horizon to build their nest egg but at the same time averse to the risks of stock market. Consider all the options before investing in annuities. Read the fine print and understand clearly all the aspects of the contract before entering into it.

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