When it comes to low-risk investing, annuities have traditionally been considered a good option. Generally associated with a steady stream of income, they can provide security for those looking to grow their savings and protect against market volatility.
But it’s important to understand that annuity purchasers have options at the end of their term. A common type of annuity is a deferred fixed annuity which offers the flexibility of a lump sum payment at the end of the investment period rather than making payment throughout the life of the annuity or the owner’s lifetime.
Key Takeaways
- A deferred fixed annuity is an annuity that offers the flexibility of a lump sum payment at the end of the investment period rather than continuous payments throughout a specified period.
- Deferred fixed annuities offer a fixed annual percentage yield (APY) rate and tax-deferred growth.
- Deferred annuities also typically have higher rates of return in exchange for less liquidity when compared to other investments, such as certificates of deposit.
- Deferred fixed annuities are not suitable for individuals that need a consistent stream of income now but rather for those who have a longer investment horizon.
- You do not owe taxes on your gains in a deferred annuity and are only taxed once you start receiving income.
Understanding Deferred Fixed Annuities
While deferred fixed annuities don’t immediately pay a consistent stream of income, they do offer some important benefits. Among these are a fixed annual percentage yield (APY) rate and tax-deferred growth, which can help to grow savings over time without being subject to interest rate changes or market fluctuations.
Serving as a great alternative to savings vehicles such as high-yield savings accounts or certificates of deposit (CDs), deferred annuities also typically have higher rates of return in exchange for less liquidity. They also generally have more flexibility than CDs by allowing investors to withdraw up to 10% of their funds each year after the first contract year.
For investors who do want to opt for a steady income stream, deferred annuities can also provide payout options upon annuitization as an alternative to lump-sum payments. If investors choose to go this route, deferred annuities typically offer regular fixed payments over the course of five to 10 years, or life, which can serve as a guaranteed form of income.
What to Consider
Determining whether a deferred fixed annuity is right for you comes down to your personal goals and investment horizon. For investors who need a consistent stream of income now, an immediate annuity may be a better option. With this type of product, investors are guaranteed regular fixed payments throughout the lifetime of the annuity, though it’s worth noting that immediate annuities don’t benefit from tax-deferred growth the same way that deferred annuities do.
For those with longer investment horizons of three to 10 years, a deferred fixed annuity could provide a higher rate of return and act as a great alternative to high-yield savings accounts or CDs. In addition to protecting your savings, a deferred annuity can also provide peace of mind by removing the risk associated with market volatility. For investors seeking financial security, this can help to create balance within their portfolios.
Taxes
You do not owe taxes on the growth of your deferred annuities so long as your funds are in the annuity. Once you start receiving the income from your annuity, then you will owe income tax on the amount received.
If you are younger than 59 1/2 and you take a lump sum on the annuity or cancel the contract, the IRS will charge you a 10% penalty. Therefore, deferred annuities work best as a long-term retirement investment.
Can You Lose Money in a Fixed Annuity?
You cannot lose money in a fixed annuity. Fixed annuities are not linked to any market-related asset or benchmark, such as an index. Annuities earn an interest rate, like a certificate of deposit, so your money cannot be lost.
Are Deferred Annuities Taxable?
Yes, deferred annuities are taxable once income payments are made. They are not taxed before and grow tax-deferred. Once an individual starts receiving payments, deferred annuities are taxed at one’s income tax rate.
Can You Take All of Your Money Out of an Annuity?
Yes, you can take all of your money out of an annuity but the details vary on the type of annuity and age. In most cases, when you take money out of an annuity, you will have to pay taxes, and depending on other factors, you may have to pay a surrender charge. Also, for some annuities, if you are under age 59 1/2, you will have to pay a 10% penalty, like you would on an early withdrawal of a 401(k) plan.
How Do You Avoid Taxes on an Inherited Annuity?
If you inherit an annuity there is no way to avoid paying taxes. You will have to pay taxes on your inherited annuity but it depends if you inherit the annuity as a spouse or another beneficiary. Spouses do not have to pay taxes until they start receiving distributions. If you are another beneficiary, you have payout options regarding the annuity, and depending on the type of payout, how you will be taxed.
The Bottom Line
Different types of annuities serve different needs, so deciding which type is best for you comes down to understanding your short- and long-term goals as well as your overall financial priorities. While investing always carries some level of risk, lower-risk options such as deferred annuities can help to provide a safety net irrespective of market behavior.
If you’re looking for a longer-term investment that can help you grow your money safely and act as a counterbalance to market swings, fixed deferred annuities could be a good option for you.