Annuities are easy to understand. I already introduced the simple single premium annuity but like most things in life it gets a little bit more sophisticated. Notice that I say sophisticated not complicated; Deferred Annuities are easy if you look at them the way I do! There are zealots on both sides of Deferred annuities, I don’t do it often on this blog but I am taking the emotion out of it.
Introduction to a Deferred Annuity?
The easiest way to think about a deferred annuity is like the picture above! You are going to put money into the deferred annuity, either in a lump sum or in installments, by sending money to an insurance company. The money stays in there growing, either at a fixed rate or a variable rate, until you turn on that hose thing where it will come in equal installments. *Those installment payments could be based on promises by the insurance company regardless of whether the principal grows*
While all deferred annuities grow tax deferred, meaning their growth isn’t taxed as it grows, they are usually categorized by their growth factor. So there are two types:
- Fixed Deferred Annuity
- Variable Deferred Annuity
How does a Fixed Deferred Annuity Work?
As the name indicates a the dollars held inside our bucket grows at a fixed rate. There is almost always a teaser rate for a year or two and then the rates come down. Think of it is a Super CD, where you may get a higher rate as compared to a CD but you are stuck with larger penalties commonly referred to as surrender charges.
How does a Variable Deferred Annuity Work?
Variable annuities are built upon the same bucket model, except the growth is based on some investments found within the product, or alternatively the bucket could grow just based on promises by the insurance company. Variable Deferred Annuities usually have large fees associated with them, and because of these fees they were/are demonized without real research into whether it is a good retirement vehicle for your situation or your family.
These products may come with some great riders including:
- Guaranteed Minimum Income Benefit – As Defined by Investopedia: Receiving a guaranteed minimum income benefit ensures that an annuitant will receive a payment regardless of market conditions. This minimum payment amount is predetermined by assessing the future value of the initial investment. This option is only beneficial to annuitants who plan to annuitize their annuity.
- Guaranteed Minimum Accumulation Benefit – As Defined by Investopedia : A rider on a variable annuity, which guarantees the minimum amount received by the annuitant after the accumulation period, or a set period of time, is either the amount invested or is locked in gain. This protects the value of the annuity and the annuitant from market fluctuations.
- Guaranteed Minimum Withdrawal Benefit – As Defined by Investopedia: This specific option gives annuitants the ability to protect their retirement investments against downside market risk by allowing the annuitant the right to withdraw a maximum percentage of their entire investment each year until the initial investment amount has been recouped.
Each rider is basically set up to protect from the downside risk of the market, and that right there is the reason Deferred Annuities are sold, hence, why I keep saying payouts may be “based on promises by the insurance company.”
Are Deferred Annuities for Everyone?
Absolutely not. It is that simple they just aren’t. Could they be right for your family, YES.
- Do market fluctuations scare you?
- Do you want a guaranteed income stream, but don’t need it now?
- Do you need another vehicle to save tax deferred?
If you answered yes, then a deferred annuity may be right for you.
Do you own a Deferred Annuity? Tell us about it.