A Deferred Income Annuity (DIA) can provide a future source of guaranteed income that will last the rest of your life. With a DIA, you invest a lump sum or make multiple purchases to receive a long-term regular payout. The DIA provides guaranteed income beginning at a future date of your choice. This can be anywhere from 13 months to 40 years from the annuity purchase.
Deferred Income Annuities are designed to provide regular income to help cover essential living expenses in retirement. Generally, the longer you defer taking income, the greater your steady retirement income can be. This is income for the rest of your life, and can also continue to provide for the rest of your spouse’s life, no matter how long both of you live.
How does a Deferred Annuity work?
A Deferred Annuity has two distinct phases: an accumulation phase, where money grows tax-deferred, and a payout (or annuitization) phase, where the accumulated value is disbursed in periodic payments. Deferred Annuities are a common strategy for long-term retirement planning.
When you purchase a deferred annuity, you either pay either a lump sum or a series of premiums over time. During the accumulation phase, the money in the contract grows without being taxed annually. This phase can last for years or even decades.
Taxes are only owed when funds are withdrawn or converted into income payments, at which point the earnings portion is taxed as ordinary income.
The length of the accumulation phase is flexible and depends on the contract terms and the owner’s goals. Some contracts allow the owner to choose when to begin receiving payments, while others specify a set annuitization date. Once the payout phase begins, the annuity can provide income for a fixed period, for the owner’s lifetime, or for the joint lives of two people, depending on the payout option selected.
What are the different types of Deferred Annuities?
Deferred Annuities are usually divided into three main categories, distinguished by how the underlying funds are invested and how returns are credited.
Fixed (Deferred) Annuities guarantee a specific interest rate for a set period. The account value grows predictably. These are popular with people who prioritize stability over growth potential.
Variable (Deferred) Annuities allow the owner to allocate premiums among a selection of investment subaccounts, similar to mutual funds. Returns fluctuate with market performance, meaning the account value can rise or fall. Since the owner bears the investment risk, variable annuities can provide greater growth potential. However, they also have greater uncertainty.
Indexed (Deferred) Annuities (sometimes called Fixed Indexed Annuities) credit interest based on the performance of a market index, such as the S&P 500, subject to caps, participation rates, or spreads set by the insurer. These are for people who prefer a “middle ground.” There is more growth potential from market gains, and a guaranteed minimum return for individuals worried about losses.
What are the tax advantages associated with a Deferred Annuity?
The tax-deferred growth of annuities is a key consideration for including these options in a retirement portfolio. Contributions to a non-qualified annuity (purchased with after-tax dollars) are not tax-deductible. However, earnings are not taxed until withdrawn. When withdrawals begin, earnings are taxed as ordinary income under a “last-in, first-out” rule, meaning gains are typically withdrawn before principal.
But make note: withdrawals made before age 59½ may also be subject to a 10% early withdrawal penalty from the IRS, like other types of retirement account.
What should I consider before purchasing a Deferred Annuity?
Deferred Annuities are long-term contracts. Their ultimate value to you depends on a number of personal factors, such as liquidity needs, risk tolerance, and retirement timeline.
Also, the costs involved with a Deferred Annuity have to be evaluated. There are surrender charges (surrender periods can be long—five or ten years), fees, and the costs of any riders that can affect overall value. And because annuities are not federally insured, you have to analyze the financial strength of the insurer issuing the annuity.
Deferred Annuities can play a useful role in a retirement strategy by providing tax-deferred growth and a path to guaranteed income. But they must be tailored to your specific situation. Miser Wealth Partners has worked with many clients to help craft ideal annuity scenarios, and we’re ready to help you.
