Understand the differences between deferred and immediate annuities
An annuity is a contract between an insurance company and an individual in which the insurance company makes a series of guaranteed income payments in return for premium from the individual. The retirement landscape is changing, and an annuity can be a great way to help achieve a secure retirement. In fact, only an annuity can pay an income that can be guaranteed for the rest of an individual’s life. There are several different types of annuities, each designed to meet a specific guaranteed income need. An annuity is considered either deferred or immediate.
A deferred annuity has an accumulation period, which is the time between when premiums are paid and when income payment begins, which could be years later.
An immediate annuity has no accumulation period. The income payments start no later than one year after the premium has been received by the insurance company.
Below is a breakdown of the most common types of deferred and immediate annuities.
• Fixed (Traditional) – During the accumulation period of a fixed deferred annuity, the contract earns interest rates set by the insurance company based on the performance of the company’s own general portfolio account. The company guarantees that it will pay no less than a minimum rate of interest. During the income payment period, the amount of each income payment is set when the payment begins and will not change.
These are especially good for people looking for safe investments, tax deferral, guaranteed lifetime income, principal protection—generally for more risk-averse and age 60+.
• Fixed Indexed (FIA) – a type of fixed annuity that, during the accumulation period, earns a rate of return based on the market performance of an external index, such as the S&P 500, but is guaranteed never to be less than zero. Even though the potential for additional credited interest is based on an external index, the contract principal amount is tied to the company’s general portfolio account. This allows the insurance company to guarantee that the principal is protected from market volatility so values are not vulnerable to market dips. As a type of fixed annuity, income payments are set when payments begin and will not change.
These are especially good for people looking for safe investments-with-accumulation potential above traditional fixed returns and other safe money alternatives such as CD’s, money market accounts, tax deferral, guaranteed lifetime income with access to principal at all times, and principal protection. This is generally for the more risk-averse, while products are good for age 50+ and coming up on retirement.
• Variable – During the accumulation period of a variable annuity, premium is deposited into an account that is separate from the insurance company’s general portfolio account. The purchaser of a variable annuity chooses how the money will be invested and the rate of return will depend on the underlying performance of the investments that were selected. Because a variable annuity’s return is based on the market performance of a separate account there is potential that returns could be less than zero. The insurance company guarantees a minimum payment at the end of the accumulation stage.
These are especially good for people who are accumulation-focused and looking for market-like returns, but within a tax-deferred vehicle. They are good for those looking for a future retirement income stream, while generally being open to a higher level of risk and principal protection is not crucial. It’s more appropriate for younger people (age 40+) and older people (age 60+), who have higher income or assets.
• Immediate Income – There is no accumulation period. Immediate income annuities are usually purchased with one, lump-sum premium payment and the purchaser begins receiving payments no later than one year after the insurance company receives the premium.
These are especially good for people looking for the highest guaranteed income for life potential, but understand that they will not have access to principal amount. They are also good for people who need to start taking income immediately.
• Longevity – a type of fixed-income annuity, longevity annuities are basically a type of future individual pension plan with a deeply deferred income payout period. Contracts can be issued at any age, and income can be deferred up to 45 years. Payment from these annuities typically, but not always, begins at age 80 or later.
These are especially good for people worried about outliving their assets. It provides income protection for those who end up living beyond normal life expectancy, and for people in—or just beginning—retirement who have a sum of money that can be dedicated to providing for an uncertain need at very old ages.
As the retirement landscape continues to shift, annuities can be a great product to balance out your portfolio and safeguard retirement savings. However, it’s important to understand how each one works to pick the annuity that is best for your income needs.