There are a multitude of reasons to buy an annuity, not the least of which is the lure of a steady post-retirement income stream. But part of the planning process involves figuring out how soon you’ll need money and how you’d like to pay into the contract that puts your new financial strategy into motion.
When it comes to immediate vs. deferred annuities, what are the actual differences, and which option makes the most sense for your age, lifestyle, and economic comfort?
What is an Immediate Annuity?
An immediate annuity is a contracted retirement income product that a consumer, also called an annuity owner, purchases from an insurance company. That contract turns a lump-sum premium into a series of payments that can potentially last a lifetime.
The most common type of immediate annuity is a single-premium immediate annuity (SPIA). In fact, the terms “immediate annuity” and “SPIA” are often used interchangeably. All SPIAs are funded via a single payment that gives the insurance company the total annuity principal up front. This usually requires a sizable transfer of funds, which is why people often set up a SPIA using money from a long-term savings account, recent inheritance, or a matured 401(k) or IRA.
Because an immediate annuity is funded in full up front, payouts can begin immediately or up to 12 months after the contract is signed. As funds are distributed, the remaining value in the account earns interest to grow over time. There are several factors that help determine the size of your immediate annuity payments:
- Annuity type: The interest generated by your immediate annuity is most influenced by whether you’ve purchased a fixed-interest, fixed-index, or variable annuity.
- Premium size: A $500,000 premium paid out over 20 years will result in a much higher recurring payout than a $50,000 premium paid out over the same time period.
- Age at time of annuitization: Younger annuitants may receive lower income distributions because the annuity has to last longer. Older annuitants may receive larger payments due to shorter life expectancies.
Note: All guarantees are subject to the claims-paying ability of the insurer.
What is a Deferred Annuity?
Deferred annuities are more of a long-term retirement strategy. You fund the annuity using a lump-sum payment or through a series of smaller payments as finances (and your contract) allow. Your money is held in an account where it can accumulate interest until a pre-determined maturity date.
You can start taking distributions from a deferred annuity as soon as 13 months post-purchase, as long as your policy has reached its contracted maturity date. You can technically make withdrawals anytime. However, withdrawals made before the maturity date, or when you’re under the age of 59 ½, may be subject to penalties from your insurance company and the IRS.
The longer your deferred annuity sits untouched, the higher your payments may eventually be. Some people purchase a deferred annuity well before retirement, watching their money grow for decades until they retire and need the income.
Immediate Annuities vs. Deferred Annuities: Key Similarities
Some characteristics of annuities apply to both immediate and deferred products.
Types of Annuities
Immediate and deferred annuities can come in three forms, each of which influences growth potential, risk, and stability.
- Fixed annuities are lower risk thanks to fixed interest rates that safeguard your principal and growth potential from market volatility.
- Variable annuities have varying interest rates that reflect the health of your subaccounts. Tying your interest rate to the market could result in greater financial growth, but it could also compromise your principal.
- Indexed annuities offer interest rates that vary according to how a market index, such as the S&P 500, is performing. They usually include minimum guaranteed interest rates to ensure account growth over time. However, they come with a cap on the amount of potential credited interest.
Tax Deferment
Immediate and deferred annuities both offer notable tax advantages in that annuitants won’t pay taxes on the money in the annuity account until they begin receiving distributions. Payments from qualified annuities are fully taxed as income. Payments from nonqualified annuities are split into two categories. The portion of an annuitant’s income that comes from post-tax premiums won’t be taxed again, but any interest that the principal generates is considered new income and can be taxed accordingly.
Note: Any reference to the taxation of annuities in this material is based on Annuitiy.com’s understanding of current tax laws. We do not provide tax or legal advice. Please consult a qualified tax professional regarding your personal situation.
Immediate vs. Deferred Annuities: Important Differences
Different annuities have varying benefits. Understanding where deferred and immediate annuities diverge can help you make an informed decision between the two.
Funding
Immediate annuities require a single payment that satisfies the product premium in full.
Deferred annuities can be funded upfront through a lump-sum payment or via a series of payments deposited over months or years.
Payout Schedules
One of the biggest differences between immediate and deferred annuities is how they stack up in terms of payout options.
With an immediate annuity, you pay your entire premium up front and start seeing payments within one year.
Deferred annuities begin making payouts at least 13 months but less than 40 years after you sign the annuity contract.
Payout Amounts
When all other factors (principal amount, interest rate, etc.) are the same, an immediate annuity will likely distribute smaller income amounts than a deferred annuity after annuitization. That’s because the money in a deferred annuity has typically generated interest on a higher principal amount for years, or even decades. Meanwhile, because immediate annuities begin distributing funds quickly, the remaining value that’s able to accrue interest diminishes over time.
Which Annuity Is Right for You?
It’s never too early to start planning for retirement. But how do you know which annuity to choose? It all comes down to your current situation and your plan for the future.
- Funding: Are you financially prepared to pay a larger lump-sum payment, or do you need time to slowly fund your annuity?
- Immediacy: Do you need a steady income stream ASAP, or can you wait a year or more to start receiving money?
- Age: Are you close enough to the 59 ½ minimum withdrawal age for annuities to take immediate payments without penalty? Or are you planning ahead and looking for a policy that will annuitize in years or even decades?
Ultimately, choosing an annuity is a deeply personal decision. Doing your research and consulting with a knowledgeable industry professional can make the process easier. For more information about annuity products and your options for guaranteed monthly income for life, reach out to an Annuity.com expert today.
