A deferred annuity is a type of insurance product that promises you safety of your invested principal and future interest payments. However, unlike a traditional fixed annuity, a deferred annuity does not make interest payments at the time of investment, but rather at some point in the future. Deferred annuities have both pros and cons and may be more suitable for some investors than others.
Safety of Principal
One reason to invest in a deferred annuity is for safety of invested principal. Insurance companies guarantee that money you place in their annuities is safe, making them very different from other investments, such as stocks. However, as with any guarantee, the value of the insurance company's promise is dependent on the financial strength of the insurance company itself.
In other words, if the insurance company fails and goes bankrupt, you are liable to lose your entire deferred annuity investment. Annuities act in many ways like a bank Certificate of Deposit (CD), which is insured by the Federal Deposit Insurance Corporation (FDIC). However, deferred annuities are not insured by the FDIC.
Tax Benefits
As with all annuities, deferred annuities enjoy tax benefits as defined by the Internal Revenue Service (IRS). Specifically, annuity earnings are not taxable until withdrawal, meaning that you do not have to pay any current income tax as earnings are accumulated. With a deferred annuity, you can usually select when you wish to begin receiving payments, thus deferring taxes as long as you feel is prudent.
Interest Payments
In addition to safety of principal, the main reason to consider a deferred annuity is if you wish to receive regular interest payments at some point in the future. Unlike regular bonds or other interest-bearing securities, most annuities do not have a maturity date, or a date at which the interest payments cease. As an insurance product, most annuities will make regular payments to you for the rest of your natural life, or possibly, over the joint life expectancy of your and your spouse. This affords you the chance to know that you will not outlive your payments and will always have a source of income for the rest of your life.
Fees
Insurance companies typically charge annual fees for insurance contracts, and deferred annuities are no different. Usually, the fees are taken out of your invested principal automatically, and serve to reduce your balance available for distribution in the future. Additionally, most annuities carry sales charges known as surrender penalties if you sell the contract before a specified time period, often as long as 7 to 10 years. Surrender fees tend to decline for each year you hold the contract, but can start at as much as 7 percent of the total value of your annuity.
Penalties
A deferred annuity falls under the IRS definition of a qualified retirement plan, subjecting it to penalties that are assigned to other accounts such as Individual Retirement Accounts (IRAs). Specifically, if you take any withdrawals from a deferred annuity before the age of 59½, you will owe a 10 percent early withdrawal penalty on the distribution. Additionally, once you reach the age of 70½, you must begin taking annual minimum withdrawals from your annuity or you will be subject to a 50 percent penalty on the amount you should have withdrawn.
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