Definition
A deferred-payment annuity, also known simply as a deferred annuity, is a type of annuity contract that delays income payments to the annuitant until a future date. This periodical delay can be tied to a specific number of periods or until the annuitant reaches a certain age. The deferment period allows the investment within the annuity to grow potentially tax-deferred, which can be beneficial for long-term retirement planning.
Examples
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Retirement Savings: John, aged 45, purchases a deferred-payment annuity that begins payouts when he turns 65. During the deferment period, his funds grow tax-deferred, providing him with an additional income stream upon retirement.
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College Fund: Maria buys a deferred-payment annuity when her daughter is 5 years old, set to start payments when her daughter turns 18. This can help fund her daughter’s college tuition through the accumulated value of the annuity.
Frequently Asked Questions
1. What are the primary benefits of a deferred-payment annuity?
One of the main benefits is the tax-deferred growth of the investment, which means that taxes on earnings are postponed until withdrawals begin. Additionally, it provides a predictable income stream during retirement.
2. Are there any penalties for early withdrawal?
Yes, most deferred annuities come with surrender charges if withdrawals are made before a certain period, typically within a specified surrender term. Additionally, withdrawing funds before age 59½ may result in a 10% early withdrawal penalty for tax purposes.
3. What types of deferred annuities exist?
Deferred annuities can be variable, fixed, or indexed. Fixed deferred annuities offer guaranteed interest rates, while variable annuities’ returns depend on the performance of the selected investments, and indexed annuities provide returns linked to a market index.
Yes, many deferred annuities offer options to convert into an immediate annuity, providing immediate income payments rather than waiting until the end of the deferment period.
5. How are deferred-payment annuities taxed?
Earnings grow tax-deferred, but once withdrawals begin, the earnings portion of the payments is taxed as ordinary income.
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Annuity: A financial product that provides a series of payments made at regular intervals, often used as part of a retirement strategy.
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Contract: A formal agreement between two or more parties that is enforceable by law.
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Annuitant: The individual who receives payments from an annuity.
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Deferment Period: The time interval between the purchase of the annuity and the start of the payout phase.
Online References
Suggested Books for Further Studies
- Annuities for Dummies by Kerry Pechter
- The Smartest Retirement Book You’ll Ever Read: Achieve Your Retirement Dreams–in Any Economy by Daniel R. Solin
- The New Retirementality: Planning Your Life and Living Your Dreams…at Any Age You Want by Mitch Anthony
Fundamentals of Deferred-Payment Annuities: Finance Basics Quiz
### When does an annuitant begin receiving payments in a deferred-payment annuity?
- [ ] Immediately after purchasing the annuity
- [ ] One year after purchasing the annuity
- [x] After a specified number of periods or reaching a certain age
- [ ] Anytime upon request
> **Explanation:** Payments in a deferred-payment annuity start after a predetermined deferment period, which might be tied to a specific time frame or the annuitant attaining a given age.
### What is the primary characteristic of a deferred-payment annuity?
- [ ] Immediate income
- [x] Delayed income payments
- [ ] Chronically mortgaged property
- [ ] Lifetime capital gains
> **Explanation:** The primary characteristic of a deferred-payment annuity is that income payments are delayed to a future date.
### True or False: A fixed deferred annuity offers guaranteed interest rates regardless of market conditions.
- [x] True
- [ ] False
> **Explanation:** Fixed deferred annuities provide guaranteed interest rates irrespective of market performance, assuring a predetermined return on investments.
### What potential disadvantage should be considered with deferred-payment annuities?
- [ ] Immediate income streams
- [ ] Lump-sum withdrawal options
- [x] Surrender charges and early withdrawal penalties
- [ ] Tax exemptions on all investments
> **Explanation:** Early withdrawal from a deferred-payment annuity can incur surrender charges and tax penalties, making it less advantageous to access funds prematurely.
### Which option involves payments that can vary based on investment performance?
- [ ] Fixed deferred annuity
- [x] Variable deferred annuity
- [ ] Indexed deferred annuity
- [ ] Fixed index annuity
> **Explanation:** Payment amounts from variable deferred annuities can fluctuate based on the performance of invested assets, as opposed to fixed and indexed options.
### Taxation on deferred annuities is typically deferred until when?
- [ ] Upon contract signing
- [x] When withdrawals begin
- [ ] Upon reaching age 59½
- [ ] Annually on growth
> **Explanation:** Tax on the earnings within a deferred annuity is deferred until funds are withdrawn, at which point the earnings are taxed as ordinary income.
### Which type of annuity links its returns to the performance of a market index?
- [ ] Fixed annuity
- [ ] Variable annuity
- [x] Indexed annuity
- [ ] Immediate annuity
> **Explanation:** Indexed annuities provide returns that are correlated with the performance of a specified market index, offering a blend of potential growth and downside protection.
### Deferred annuities are often chosen for which long-term financial goal?
- [x] Retirement income
- [ ] Short-term capital gains
- [ ] Tax shelter for real estate
- [ ] High-risk investment options
> **Explanation:** Deferred annuities are commonly utilized as a strategy to secure long-term income for retirement due to potential tax-deferred growth and predictable payouts.
### The growth phase of a deferred annuity where income is not paid out is called what?
- [ ] Annuity phase
- [x] Accumulation phase
- [ ] Distribution phase
- [ ] Immediate phase
> **Explanation:** The accumulation phase is the period during which funds are invested and grow within the annuity, prior to the commencement of monthly income payments.
### How can deferred annuities enhance retirement planning?
- [ ] By offering only short-term investment options
- [x] By providing tax-deferred growth and assured income streams
- [ ] By mandating immediate withdrawals
- [ ] By incurring high upfront fees
> **Explanation:** Deferred annuities are an effective tool for retirement planning due to tax-deferred growth and future-guaranteed income, thus creating financial stability post-retirement.
Thank you for exploring the robust nature of deferred-payment annuities and testing your understanding through our detailed quizzes. Continue seeking knowledge to fortify your financial future!
