deferred vs immediate annuity

Deferred vs. Immediate Annuities: What's the Difference?

An annuity is an excellent way to create a nest-egg for your future retirement. It protects a portion of your retirement benefits from loss through investments and gives you a chance for growth. Annuities have two main types: deferred and immediate. Knowing how they vary can help you save better for the future and create income that's perfect for your lifestyle.

Deferred Annuity

With deferred annuities, payments do not start immediately after the premium payment. Instead, you make installments or one lump sum to guarantee that you'll receive a regular income at a specified time in the future. Most people set up a deferred annuity to have a stream of revenue after they retire.

A deferred annuity has two phases: savings and income. During the savings period, a person makes regular payments toward their premium, which is then invested by an insurance company to help it grow. These investments are tax-deferred. After the date when you can begin making withdrawals from your investment, you'll begin receiving regular payments from your insurance company. These payments start the "income phase." At this point, the funds are subject to income tax.

With this type of annuity, you're restricted from early withdrawals. If you begin making withdrawals before the age of 59 and a half, you'll be subject to IRS tax penalties. A benefit of deferred annuities is that you can assign a beneficiary to receive the principal and investment earnings in the event of your death.

Immediate Annuity

Purchasing an immediate annuity is done in one large lump sum, and you usually do not have the opportunity to make payments. Unlike a deferred annuity, your income starts almost immediately after the premium is paid, thus the "immediate" portion of this investment. However, you do have the option to defer your payments up to 12 months. The funds will be invested by the annuity company and will continue to accumulate tax-deferred interest. If you do choose to receive immediate payments, your revenue is taxed like regular income.

With this type of annuity, you don’t need to worry about tax penalties for making withdrawals before you’re 59 and a half. Depending on the kind of annuity that you purchase (fixed or variable) your payments can either be steady or change month to month. Your income is also dependent on your age and gender because the revenue is supposed to last a full lifetime. It is up to the annuity company to determine how long you'll live and how long you'll need to receive income.

The biggest drawback for immediate annuities is that you cannot change your mind following the purchase. After you’ve entered into this savings plan, it is irreversible. This situation can have a negative impact if you need a large sum of emergency money soon after you enter into the contract. A second drawback is that many immediate annuities terminate after the death of the insurer. Thankfully, you can purchase a joint and survivor annuity that will cover your lifetime and the lifetime of another person.

Last Updated: January 30, 2017