 Personal Finance PowerPoint Presentation, Deferred Anuity. Prepare to get financially fit by practicing personal finance. Most of this information can be found at Investopedia Deferred Anuity, which you can find online. Take a look at the references, resources, continue your research from there. This by Julia Kagan, updated February 18, 2021. In prior presentations, we've been looking at insurance in general. We've moved on to the life insurance. And now we're talking about annuities asking the question of what is a deferred annuity? A deferred annuity is a contract with an insurance company that promises to pay the owner a regular income or a lump sum at some future date. So when we think about annuities in general, we think about basically a series of payments. You would have a deferred annuity as a type of say investment tool. Then you would have the lump sum going in and then promise basically payments that are going to be happening at some future point. Those payments not starting until some future point that given the deferral component, which means you might have some ability or given the annuity some ability possibly to grow before the actual payments go out. This can be used as a tool as part of basically a retirement planning kind of tool hoping and helping possibly some of your money to go a little bit further, as well as give a little bit more some security in some cases. So investors often use deferred annuities to supplement their other retirement income such as social security. Deferred annuities differ from immediate annuities, which begin making payments right away. So if you're putting money into the deferred annuity, you'd have to plan a little bit more in advance to do so because the payments aren't going to be starting right away. Whereas if you're close to be needing the payments at this point and you're saying I need my nest egg to go a little bit further, then you might be wanting to look at like the immediate annuity where you put the money in and the annuity payments basically start right away. How deferred annuities work? So there are three basic types of deferred annuities fixed indexed and variable as their names implies fixed annuities promise a specific guaranteed rate of return on the money in the account. So that's kind of like the most conservative type of thing to do. You'd have the fixed annuity and you're probably not going to get as much of a return or have the potential to get the return that you might have for like a variable kind of annuity. But because everything is fixed, it's more of a guaranteed kind of thing. And if you're thinking of it kind of to hedge or safeguard against other retirement tools that you might be using, which are subject to market fluctuation possibly in a little bit more so than that could be a way to go to kind of hedge or give some more balance and some more security possibly. So index annuities provide a return that is based on the performance of a particular market index such as the S&P 500. So you can imagine when you're looking at what's actually happening in the insurance company, it's kind of like what happens in a bank. How does the bank make money when they're just holding on to my checking account? Well, they're not holding on to all the money, they're investing the money and they're making a return on it. So the same kind of thing is going on here. They're taking the money and investing it and then doing their risk mitigation to see what's going to be an appropriate amount for the annuity charge in order to do that, for example. If they give you some fluctuation based on the investments such as tying it to an S&P 500 or something like that, then you're going to be taking on some of the benefit that if there's a fluctuation in the market upward that could be a good thing. But of course with that risk comes the potential that the market goes down, which would be a bad thing. So it's not as stable then as the fixed type of annuity. It just really kind of depends on what you're looking for in your overall kind of plan or strategy as to whether you would want to take on more risk and possibly get access to more gains or not. So the return on variable annuities is based on the performance of a portfolio of mutual funds or subaccounts chosen by the annuity owner. All three types of deferred annuities grow at a tax deferred basis. Owners of these insurance contracts pay taxes only when they make withdrawals, take a lump sum or begin receiving income from the account. At that point, the money they receive is taxed at their ordinary income rate. So the period when the investor is paying into the annuity is known as the accumulation phase or saving phase. So you're going to be it's deferred. So you're putting money in, it's accumulating upwards before you're taking the money out because it's not an immediate annuity. Once the investor elects to start receiving income, the payout phase or income phase begins. So many deferred annuities are structured to provide income for the rest of the owner's life and sometimes for their spouse's life as well. So in other words, when you put money into the into the annuity, you could have the tax benefit at least on the growth stage, right? Because when you put the money into the annuity, then you would think at that point in time that component is principal, not income. So you wouldn't expect a tax kind of situation at that point. But when the annuity is basically growing or earning, if it was outside of an annuity like in a bank account or savings account or in the stock market, you might have gains, you might have interest, you might have dividends, and those would be typically taxable. But if they're in the annuity as it's growing during the growing period, you may not have the tax consequences of that growth component. So special considerations, deferred annuities should be considered long-term investment because they are less liquid than, for example, mutual funds purchased outside of an annuity. So one of the downsides of an annuity would be that it's not in say just the market where if you had like a lump sum money that you're just going to put into the market, then you might be saying, hey, I'm just going to live off of the income, the dividends and interest or something that come off it. But it's still liquid. If you needed an emergency, you can access that money. If it's an annuity, you don't have that same kind of access. You're getting the payment stream. You paid for the payment stream, but you locked in to the annuity. So that's one part of the contract by locking into the annuity for the future payment stream. You might get a more beneficial payment stream in some cases, but you can't just say, okay, give me my principal back at any given time. That's part of the contract with basically the annuity company. So those are the pros and cons or some of them. Most annuity contracts put strict limits on withdrawals such as allowing just one per year withdrawals may also be subject to surrender fees charged by the insurer. In addition, if the account holder is under age 59 and a half, they will generally face a 10% tax penalty on the amount of the withdrawal. So that's kind of similar to say an IRA or 401k plan where these tools are generally designed for retirement. So if you were to get into it earlier, then the tax code, you know, you might have this penalty that you got to deal with the 10% penalty, which can be significant. That's on top of the income tax they have to pay on the withdrawal. So there obviously could be tax implications on the withdrawal as well. Prospective buyers should also be aware that annuities often have high fees compared with other types of retirement investments. So putting stuff into like a 401k or an IRA, for example, is really pretty easy to do because you're basically just saying, I'm just going to put money into the stock market, which you can do basically using online tools these days like e-trade or something or like Vanguard or something like that. And then put it under the umbrella of basically an annuities, which is pretty straightforward kind of thing. So you get a little bit more complex when you get into more complex tools like an annuity and more complex tools that are going to have higher fees typically. Fees can also vary widely from an insurance company, from one insurance company to another, so it pays to shop around. Finally, deferred annuities often include a death benefit component. If the owner dies while the annuity is still in its accumulation phase, their heirs may receive some or all of the accounts value. So then, you know, at that point in time when it's accumulating and you die at that point in time, you could have like a kind of a life insurance component to it in that case as well. So if the annuity has entered the phase out phase, however, the insurer may simply keep the remaining money unless the contract includes a provision to keep paying benefits to the owner's heir for a certain number of years. So you want to take into consideration kind of like your life expectancy and what's going to happen if you died before that and what's going to be the consequences in terms of your heirs with regards to the annuity.