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What Is a Deferred Annuity & How Does It Work?

Retirement Planning
Couple jogging by a sunflower field, discussing a deferred annuity

Different types of annuities can help meet different needs. If you want income from an annuity right away, consider purchasing an immediate annuity. If you are planning for your future and want to receive that income later, then a deferred annuity can help with that.


With deferred annuities, you can receive a lump sum or an income stream at retirement or at another time when funds are needed. Such annuities are designed for long-term use, so they are suited for retirement or long-term growth. For example, someone who is 50 years old might purchase a deferred annuity with the intention of receiving income at the age of 65 or even at 80. The greater the length of time between your annuity purchase and the payout, the more time the value will have to potentially grow. Annuity growth is not always guaranteed, depending on the type of deferred annuity you purchase.

How Does a Deferred Annuity Work?

A deferred annuity goes through two phases: the accumulation phase and the payout phase.

Accumulation Phase

During the accumulation period, the value of your annuity may grow. How the growth occurs will depend on which type of deferred annuity you select.

Payout Phase

At the end of the accumulation phase, you can choose to take the money as a lump sum without incurring a tax penalty as long as you are 59 1/2 years old. You could also elect to annuitize that money and begin receiving an income stream. Some people might consider supplementing other retirement income sources with that money. Withdrawals taken from an annuity are subject to ordinary income tax, and if taken prior to age of 59 1/2, are subject to an additional 10% tax penalty.

Any earnings on your annuity are tax-deferred during the accumulation phase. That means you won't pay taxes on those earnings until you withdraw the funds. Withdrawals from a non-qualified annuity are subject to ordinary income tax, and if taken prior to age of 59 1/2, are subject to an additional 10% tax penalty. Withdrawals from a tax-qualified annuity, such as an IRA, are taxed in full upon receipt.

Different Types of Deferred Annuities

There are different types of deferred annuities. Here are a few common types.

Fixed Annuities

With fixed deferred annuities, the growth of the annuity is subject to the interest rates terms described in the annuity contract you purchase. For example, the length of any interest rate guarantee is stated, as well as the terms for earning interest as declared by the company in addition to a guaranteed rate.

A fixed annuity can help provide reliable, predictable growth of the annuity value. But the trade-off is that even if general interest rates or inflation increase, you may be limited in terms of the additional interest you will receive above the guaranteed interest.

Variable Annuities

The growth of a variable annuity is determined by the performance of how the annuity value is allocated by the purchaser among the contact's investment options, which are known as subaccounts. These choices could potentially lead to greater growth than a fixed annuity. But growth is not guaranteed with a variable annuity and principal value may be lost due to unfavorable performance of the options. Past performance is not an indication of future results.

Fixed Indexed Annuities

The potential growth of a fixed indexed annuity is tied in part to the performance of a financial index, such as the S&P 500. Your money is not invested directly in the stock market, however, so your annuity return will not exactly match the index. A benefit of this type of annuity is that account value guarantees will prevent loss of value from poor index performance.

This type of annuity also has limits on the increase in value tied to index performance. For example, a fixed indexed annuity might limit growth to 80% of gains in the index. This is called a participation rate. In this example, if the index increased by 5%, your value would go up by 4%.

Generally, indexed annuities carry more risk than fixed annuities, but less risk than variable annuities. The fixed annuity will have a minimum guaranteed rate of interest. With an index annuity, downside risk from the index is limited by the guarantee. A variable annuity could lose value from the variable options; though typically there is also a fixed option with a guaranteed interest rate.

Deferred Annuities & Preparing for Retirement

If you have maximized your contributions to a retirement savings account, like a 401(k) or an individual retirement account (IRA), you might consider purchasing a deferred annuity. Although contributions to 401(k) accounts and IRAs are restricted to annual limits set by the IRS, there is no IRS limit on the amount of money you can use to purchase an annuity. This could help you increase the money you have available in retirement, while any growth is tax-deferred until received. If you have more questions, consider speaking with a financial representative.

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