Deferred Annuity

A deferred annuity is an investment product that offers tax-deferred growth of the invested funds and provides income payments at a future date, which could be either a specified later date or when the policyholder reaches a stipulated age. It’s primarily used as a tool for retirement planning, helping individuals ensure a steady stream of income during their retirement years.

Detailed Explanation

Deferred annuities can be classified into different types based on certain criteria, such as:

Fixed Deferred Annuities: These provide a guaranteed interest rate for a specified period. The income payments are also fixed and guaranteed.
Variable Deferred Annuities: These allow the policyholder to invest in a variety of sub-accounts, which can include mutual funds. The payments vary based on the performance of these investments.
Indexed Deferred Annuities: These are tied to a market index (like the S&P 500), offering the potential for higher returns while also providing some level of guaranteed minimum income.

Examples

Example 1: Retirement Planning: John, a 50-year-old marketing executive, invests in a deferred annuity that starts paying out when he turns 65. He contributes $5,000 annually until he retires. This annuity helps John ensure a steady stream of income during retirement, supplementing his Social Security and other retirement savings.
Example 2: Education Savings: Mary and Tom purchase a deferred annuity for their newborn’s college education. They invest regularly into the annuity, which starts paying out when their child reaches 18. The tax-deferred growth helps maximize the return on their contributions.

Frequently Asked Questions

Q1: What is the primary benefit of a deferred annuity?

A: The primary benefit is the tax-deferred growth, which means the earnings on the invested funds are not taxed until they are withdrawn. This helps the investment grow over time without the burden of annual taxes.

Q2: Are there any penalties for early withdrawal?

A: Yes, if funds are withdrawn before the age of 59½, there is usually a 10% penalty on earnings in addition to regular income taxes.

Q3: What is the surrender period?

A: The surrender period is the length of time where withdrawals from the annuity are subject to surrender charges. This period varies but commonly ranges from 5 to 10 years.

Q4: Can I lose money in a deferred annuity?

A: In a variable deferred annuity, the investment performance can lead to gains or losses. Fixed and indexed annuities provide more safety but usually with lower growth potential.

Q5: How are the payments received from a deferred annuity taxed?

A: Payments are usually taxed as regular income. The portion of each payment that constitutes return on investment (cost basis) is not taxed, but earnings are.

Immediate Annuity: An annuity where the payments begin almost immediately after the investment is made.
Annuitization: The process of converting the investment in an annuity into a series of periodic income payments.
Surrender Charge: A fee paid for early withdrawal from an annuity.
Tax Deferral: Taxing the earnings on an investment at a later date rather than when the income is earned.

Online References

Suggested Books for Further Studies

“Annuities For Dummies” by Kerry Pechter
“The Annuity Stanifesto” by Stan The Annuity Man
“The New Retirementality” by Mitch Anthony
“The Retirement Miracle” by Patrick Kelly

Accounting Basics: “Deferred Annuity” Fundamentals Quiz

### How does a deferred annuity primarily benefit investors? - [x] Through tax-deferred growth - [ ] Immediate access to funds - [ ] Guaranteed early withdrawals - [ ] High annual dividends > **Explanation:** Deferred annuities primarily benefit investors by allowing the earnings to grow tax-deferred, meaning taxes are not paid on earnings until funds are withdrawn. ### When do payments from a deferred annuity typically begin? - [ ] Immediately after purchase - [ ] At the next financial quarter - [x] At a specified future date or age - [ ] At the start of the tax year > **Explanation:** Payments from a deferred annuity typically begin at a specified future date or when the policyholder reaches a specified age. ### Which type of deferred annuity is associated with market index performance? - [ ] Fixed Deferred Annuity - [ ] Immediate Annuity - [x] Indexed Deferred Annuity - [ ] Life Deferred Annuity > **Explanation:** An Indexed Deferred Annuity is associated with market index performance, offering potential for higher returns while providing some level of income guarantee. ### What is a surrender charge in context to annuities? - [x] A fee for early withdrawals - [ ] A bonus for maintaining the annuity - [ ] A tax penalty for contributions - [ ] An administrative fee > **Explanation:** A surrender charge is a fee paid for early withdrawals from an annuity. It discourages policyholders from liquidizing their funds prematurely. ### Can earnings on a deferred annuity be taxed while they're still in the account? - [ ] Yes, annually - [x] No, they grow tax-deferred - [ ] Only during declaration of retirement - [ ] Only if withdrawals are made after 70½ > **Explanation:** Earnings on deferred annuities grow tax-deferred, meaning they are not taxed while still in the account and tax is deferred to the withdrawal phase. ### What age must one typically reach to avoid penalties on early annuity withdrawals? - [ ] 55 - [ ] 60 - [x] 59½ - [ ] 65 > **Explanation:** To avoid penalties on early annuity withdrawals, one must typically reach the age of 59½, otherwise a 10% penalty on earnings in addition to regular income taxes applies. ### What are the two primary forms of deferred annuities? - [x] Fixed and Variable - [ ] Indexed and Market-based - [ ] Immediate and Delayed - [ ] Gradual and Lump-sum > **Explanation:** The two primary forms of deferred annuities are Fixed and Variable. Fixed provides a guaranteed return, while Variable depends on the performance of chosen investments. ### In a fixed deferred annuity, what remains constant? - [ ] Premium payments - [ ] Policyholder's risk - [x] Interest rate - [ ] Cost basis > **Explanation:** In a fixed deferred annuity, the interest rate remains constant, providing a steady and guaranteed growth on the invested funds. ### Which type of account is often compared with deferred annuities for their tax advantages? - [x] Traditional IRAs - [ ] Savings accounts - [ ] Checking accounts - [ ] Emergency funds > **Explanation:** Traditional IRAs are often compared with deferred annuities for their tax advantages as both provide tax-deferred growth. ### At what phase do deferred annuity payments begin converting into periodic income? - [ ] Accumulation phase - [ ] Exponential growth phase - [ ] Dividend investment phase - [x] Annuitization phase > **Explanation:** Deferred annuity payments begin converting into periodic income during the Annuitization phase, marking the transition from saving to receiving payments.

Thank you for exploring the fundamentals of deferred annuities and engaging in our enriching sample exam quiz questions. Keep pursuing excellence in your financial knowledge and planning!

Deferred Annuity