If you’re looking for stock-market like returns with downside protection, or a guaranteed fixed interest rate greater than a CD or the Treasury rates, a deferred annuity might be right for you.
What is a deferred annuity?
A deferred annuity is an annuity contract that delays income payment until the annuitant decides to receive them. That’s accomplished by splitting the account in two phases, the accumulation phase and the distribution phase. During the accumulation phase, a deferred annuity’s growth is tax deferred.
The growth is taxable in the year you begin your distribution phase and begin receiving payments. In contrast with immediate annuities, deferred annuities include a death benefit, which is normally equal to your initial investment.
Why do people buy deferred annuities?
For the most part, people who invest in deferred annuities are looking to grow their money on a tax-deferred basis in an account that offers a fixed return, or a variable return with more risk, and a guaranteed death benefit.
There are also several add-ons that investors find particularly attractive in these accounts. One of the most popular guarantees a high compounding annual return, between 5%-8%. Others offer smaller annual guarantees but lock-in the market highs so your income only grows and never loses.
Types of Deferred annuities
There are three types of deferred annuities, fixed, index, and variable. The first works like a CD with a fixed interest rate, while the last two offer participants an opportunity to make higher returns through the stock-market, or a stock-market crediting system.
Fixed Deferred Annuity
You can think of a fixed annuity as a CD with higher interest rates and normally a longer period of surrender. With this investment vehicle, your initial funds are credited to an accumulation account.
The life insurer then credits the account with a fixed amount of interest. There is a minimum guaranteed interest rate, which is guaranteed when the insurer begins lower rates. Researching an insurer’s history of paid interest is advised when considering a fixed annuity.
Index Deferred Annuity
The index annuity was created to rival the returns of a fixed annuity with higher earning potential through the utilization of an account that is credited based on the performance of its underlying investment in the stock market. In other words, with an index deferred annuity your money is not invested in the stock market.
Instead, you choose from a series of crediting strategies that credit monthly, semi-annual, annual or every 2 years. Some strategies limit the amount of investment return to be credited to your account called a Cap.
While all index deferred annuities feature a participation rate, which is the percentage of your return that’s Capped. You want to research both, but in short, look for an index annuity with 100% participation rate and an Uncapped strategy.
Variable Deferred Annuity
No different than an index deferred annuity, the variable deferred annuity was created to compete with the returns of a fixed annuity with higher returns in account that is ACTUALLY invested in the stock market.
Variable annuities give investors the flexibility of investing in professionally managed sub accounts with various of asset classes, including, money market, bonds, and stocks, giving investors the potential to generate high rates of returns and increase the amount of capital they can accumulate.
Funding a deferred income annuity with Qualified or Non-qualified Funds.
How you’ll pay tax on your annuity depends rather the money you used to fund it is qualified or non-qualified.
Qualified Deferred Annuities
If the annuity is funded with money that has not been taxed, it’s considered a “qualified” for IRS execution from income taxes. The whole monthly payment received from a deferred annuity (since income tax has not been paid).
Qualified annuities can be funded from corporate-sponsored retirement plans such as Defined Benefit or Defined Contribution, Lump Sum distributions from such retirement plans, or from individuals arrangements like IRAs, SEPs, and Section 403(b) tax-sheltered annuities, or Section 1035 annuity or life insurance exchanges.
Non-qualified Deferred Annuities
Non-Qualified deferred annuities are funded with monies that has not enjoyed the benefit of a tax-free status or exception and for which taxes have already been paid. Each payment received is considered a repayment of previously taxed principal and therefore excluded from taxation.
Non-qualified deferred annuities are traditionally purchased by individuals investing their money market accounts, CD’s, after-tax savings, proceeds from the sale of a property, mutual funds, business, other investments, or from a life insurance payout.