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Understand the difference between immediate and deferred annuities

by Maurice Draine | Contributor
October 5, 2020

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Annuities are insurance products that can be used for retirement. As an insurance product, you may set up your annuity to pay your beneficiary should something happen to you. However, if you retire and the annuity matures, it pays you in payments as determined by the policy. Annuities can be the perfect blend of an insurance policy and a retirement savings plan.

One of the best options of an annuity is its flexibility regarding payouts. Annuities can be paid out immediately or over time (or deferred). It’s important to understand the difference between these options and which is best for your needs.

What is an annuity?

Before delving into the payout terms of an annuity, it is essential to understand the annuity definition. An annuity is not a traditional insurance plan, and it is not a conventional retirement plan. It is a hybrid of both.

Annuities can be funded through a lump sum payment made by the insured or through premium payments made over time. With interest, the annuity matured to more than the value paid into it.

Unlike most insurance policies, an annuity is also designed to release payments to the insured upon retirement in a pre-determined manner: payments over time or a lump sum payment. Additionally, the insured can borrow against an annuity after they reach age 59½ without any tax penalties.

What are the benefits of an annuity?

Annuities offer unique tax benefits for the insured. The tax benefits and investment options make it an excellent option for most buyers.

The benefits of annuities include

  • Tax-deferred contributions
  • No tax on earned interest while sitting in the annuity
  • No maximum annual contribution
  • Supplements pensions and Social Security in retirement

Of course, once you receive payouts or withdraw from an annuity, you will have to pay taxes on your income. However, annuities offer an excellent opportunity to save taxes while saving money while working and paying into the annuity.

What are annuity payout options?

One of the most appealing pieces of an annuity is its flexible payout options. An insured can choose the type of payout they wish to receive when setting up the annuity. Annuities can include several different payout options , including:

  • A guaranteed payout period. This period means you set the terms of the payout. If you die within those terms (five years, 10 years, 30 years, etc.), your beneficiary will continue to receive payouts until the guaranteed period ends.
  • Lifetime payments. While you are alive, you receive payments. When you die, payments end.
  • Lifetime payout with a guaranteed payout period. This option can be a little more confusing, but is often the most popular option. This option gives you payments while you are alive. However, you also include a guaranteed or period-certain phase. If you outlive this phase, you will continue receiving benefits until you die. However, if you do not survive this phase, your beneficiary will receive payments until the period ends.
  • Joint and survivor annuity. You get payments until you die, and your survivor gets payments until he or she dies.

What are immediate annuities?

Immediate annuities are purchased with a lump sum of money. In exchange, buyers receive payments from the annuity immediately. The payments may occur monthly, quarterly or annually, based on the insured's wishes and contract.

Immediate annuities can be set for a specific short term to be used for a specific reason, like paying for college or a significant investment. They may also be used to supplement social security and pensions in retirement.

Immediate annuities stop paying the buyer when he or she dies. Unless the buyer sets it up as a joint/survivor annuity, beneficiaries and survivors do not receive any additional money from the annuity.

Therefore, if you die and the terms have not been reached, your insurance company keeps the remaining money.

On the other hand, if you outlive the premiums on the annuity, you continue to receive payments until you die.

What are deferred annuities?

A deferred annuity allows an investor to make payments and receive a payout at a later date. Unlike an immediate annuity, the deferred annuity can create a lump sum benefit. However, it may also create payments out over time.

Deferred annuities can include one of three investment options:

  1. A fixed-rate annuity. A fixed-rate annuity guarantees a specific rate of return on the invested funds. Think of it as a CD or a savings account. There is not variable on the return rate, no matter how the market fairs. However, since the risk is low, the rate of return is lower as well.
  2. A variable-rate annuity. A variable-rate annuity is based on an investment portfolio. The return rate varies based on the investments within the portfolio, including mutual funds, stocks, and sub-accounts. The rate of return is higher because the risk is higher.
  3. An indexed annuity. An indexed annuity uses the market index of specific markets to determine the return rate.

Can investors withdraw from an annuity before it matures?

As with any retirement savings plan, you can withdraw from an annuity at any time. However, be prepared to pay penalties and possible tax penalties if you withdraw too soon. Investors attempting to withdraw funds within the first few years may face a fee of around 7%, depending on the annuity. However, most annuity contracts allow withdrawals of up to 10% each year without fees – and some have even more generous allowances.

Furthermore, if you withdraw money before reaching age 59½, you will face an IRS penalty of 10% for early withdraw, however, there are exceptions to this rule.

Weigh your options carefully to determine if an early withdraw of funds is the right option for you.

What type of annuity is best for you?

Choosing an annuity is a profoundly personal decision. If you need money quickly for a financial emergency or are looking to pay for an immediate project, you may consider an immediate annuity.

However, if you are looking for more of an investment opportunity as well as a tax-deferred savings plan, a deferred annuity may be the best option for you.

Alliance America can help

Alliance America is an insurance and financial services company. Our financial professionals can assist you in maximizing your retirement resources and achieving your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling 888-864-2542 today.

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