Understanding Deferred Annuities: Pros and Cons

Key Takeaways

• An annuity is a contract, commonly with an insurance carrier, that pays out money over time, usually during retirement.

• Whether the chosen structure is fixed, variable, or index, the individual must also decide when it pays out..

• If an annuity is needed sooner than a year out, an immediate annuity may be better than a deferred annuity.

How is Deferred Annuity Defined?

Those seeking reliable retirement income frequently turn to a deferred annuity. An annuity is a contract, commonly with an insurance carrier, that pays out money over time, usually during retirement.

Basically, the individual contributes money up front, either over time or in a lump sum. Subsequently, their income stream is deferred until retirement.

Depending on the agreement, the annuity often pays out monthly, and usually throughout the person’s life. The contract may also pay regular survivor’s benefits to beneficiaries.

What are Different Types of Deferred Annuities?

With deferred annuities, how interest accrues depends upon the annuity’s structure. Thus, carefully assess personal needs and objectives before deciding on annuity type.

By Return

• Fix rate. Here, the insurer guarantees a minimum yield that can be the lowest of all types. Also, note the lack of protection against inflation. But those who seek guaranteed income with the least risk often go with this type.
• Variable rate. With this type, there is no guaranteed return rate. Rather, returns are based on the performance of the sub-accounts in which the money is invested. Such accounts include stocks and bonds. Thus, returns could be larger or smaller than what other annuities pay. There also may be inflation protection.
• Index. When it comes to predictability and performance, this annuity type is between variable and fixed. The investment’s performance is linked to the S&P 500 or other index, which means this index can also shield against inflation. There are also minimum and maximum return rates.

By Term

Whether the chosen structure is fixed, variable, or index, the individual must also decide when the annuity pays out. 

• Term-deferred annuities. Also called fixed-period, this annuity type is paid out over a certain period. This means that if the person dies during the contracted period, payments go to beneficiaries. However, payments will cease once the term ends, even if the person is living.
• Lifetime-deferred annuities. Here, payments are guaranteed throughout the person’s life. Payments stop with the person’s death.
• Single premium. This is established with a single funding payment, usually made when retirement is around a decade away, which can grow over time. This type can possess a fixed rate, fixed indexed, or multi-year guarantee.

What are the Advantages of a Deferred Annuity?

There are a number of benefits associated with deferred annuities. They include:

• Potential tax gains + investment flexibility. Wealth can grow within a tax-favored account. Until they are withdrawn, account earnings are not taxed. Also, if after-tax money is contributed to the account, there are no additional taxes owing. In terms of flexibility, a number of deferred annuity types are available.
• Unlimited contributions. There is no cap on account contributions, which can especially benefit higher earners who may wish to put off taxes on investment gains.
• Survivors and death benefits. For the price of the annuity, there may be a host of benefits. Those may include a guaranteed minimum lifetime payout, death benefits, survivor benefits, and more.
• More time to compound. Delaying payout means money has more time to compound. Thus, payout amounts will likely increase. 

What are the Disadvantages of a Deferred Annuity 

Their benefits notwithstanding, there are drawbacks to deferred annuities, including: 

• Complex contract. The fine print must be carefully considered since annuity agreements can be lengthy and complicated.
• Fees. There can be high fees with annuities, with the sales commission alone amounting to 6 or 7 percent. Again, scour the contract’s fine print.
• Penalties for withdrawing early. If money is withdrawn before age 59.5, tax deferral benefits may be lost and there may be a bonus penalty.
• Poor liquidity. Getting money from an annuity can be very difficult. If the contract is canceled, there may be more penalties.

Who is Eligible and Should Consider a Deferred Annuity?

There are drawbacks, but a guaranteed income stream upon retirement is attractive to many people. Purchasing a deferred annuity could make sense if retirement is nigh. Combined with Social Security, an annuity could provide a great deal of security. But research carefully first.

A variable deferred annuity might work best for those who seek the prospective return of stocks sans some of the risks. With one of those, money is deposited in stock mutual funds and others. Minimum guaranteed income may be provided.

Note that if an annuity is needed sooner than a year out, an immediate annuity may be better than a deferred annuity.

In terms of eligibility, the person can be as young as 18, depending upon their financial situation, goals, and life expectancy. Some advisors say it is best to begin receiving payments between ages 70 and 75.

What to Consider When Planning for Retirement 

Planning for retirement is one of life’s most important undertakings. Those seeking retirement income do have options, including a deferred annuity.

Another option is through Willow Wealth’s IRA, which can help build retirement wealth. Willow Wealth — one of the leading private market investment platforms — has unlocked investments for IRAs that once were restricted.

The offering by Willow Wealth allows the addition of private-market investments to tax-advantages accounts. From art to private credit to real estate, the company offers more alternative asset classes than any other platform. Some 85% of its investments are available to retirement accounts.

Accounts that can be transferred in their entirety or in part include traditional, Roth, SEP IRA, or SIMPLE IRAs. It is also possible to roll over a 401(k) or contribute new funding for any retirement account type.

Because retirement dollars are essential to optimize due to their tax favorability, individual retirement accounts can potentially be an ideal way to enhance private market growth and income.

Because of their comparably longer time horizon, an IRA can be effective in allowing private-market assets. Generally less liquid, such assets can draw improved risk-adjusted returns.

Public market volatility can render retirement portfolios vulnerable. Private assets have relatively low correlation to the stock market and can help diversify holdings. 

Private Markets and Portfolio Diversification 

Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.

Platforms like Willow Wealth provide curated access to private markets for individual investors.   

Investors can get started with minimum investments as low as $5,000 for their first investment (subject to certain exceptions). Willow Wealth offers a curated selection of opportunities across multiple asset classes, ranging from individual investments to diversified funds and automated portfolio solutions. While these investments carry risk, they open the door to opportunities across real estate, private credit, private equity, and more.  

Join more than 500,000 members and start investing in private markets today at willowwealth.com. 

In Summary

As an insurance contract, deferred annuity can generate retirement income and can make financial sense for some. However, there are risks and disadvantages, so it could be wise to discuss options with a financial advisor.

Remember, too, that rather than realizing capital gains or income upon the maturity of every private market investment, dollars can compound in a tax-advantaged retirement account.