A deferred annuity is a type of insurance policy that earns interest and eventually pays out a guaranteed income for a set period of time. If you need access to the money in your annuity before you start taking an income, you can make a withdrawal, which may have tax consequences, or you may be able to borrow against your deferred annuity, depending on the terms of your policy.
Basics of Deferred Annuities
Deferred annuities defer taxes on the interest your annuity earns until you withdraw money from the annuity. This allows the interest to grow faster, as you're not making regular withdrawals to pay taxes. You can make withdrawals from the annuity without annuitizing the annuity. Annuitizing the annuity means taking a guaranteed income stream.
Read More: Examples of Annuities
Advantages to Taking a Loan Against Your Annuity
Borrowing from your annuity doesn't have the same potential tax consequences that making an early withdrawal from an annuity does. If you're younger than age 59 1/2 and you make an annuity withdrawal, you must pay an early withdrawal penalty of 10 percent, in addition to any taxes due. If you borrow, you don't have that penalty so long as you pay back the loan within the allotted time frame (usually 5 years).
Disadvantages to Taking a Loan Against Your Annuity
When thinking about the disadvantages of an annuity loan, you will see long term damage. Because you are pulling money away from investing, your growth will substantially stall. You'll feel this mostly in retirement when you start your payouts.
Another con is the timeline. If you are not able to pay back that loan within the time specified, you will be charged a 10 percent early withdrawal fee and hefty taxes on the amount.
How to Borrow Against Your Annuity
Your annuity policy will outline whether you can borrow against your annuity. If you can't find your policy, or the policy terms aren't clear, call your insurance company and find out if you can take out a policy loan, and, if so, how much you can borrow and what the interest rate and repayment terms are. If you want to move forward with the loan, ask for the form needed to request a loan. Fill out the paperwork and return it via mail, fax or email.
There are usually limitations on the maximum amount of the loan. Most insurance companies will allow up to 50% of the value of the annuity to be borrowed. It is important to know what the limitations are with the insurance company that holds your annuity so that you know if the amount of the loan is enough for what you need.
Alternative to Borrowing
One alternative to borrowing is making a withdrawal from your annuity, and if you're older than age 59 1/2, you won't incur an early withdrawal penalty. Another alternative is using your annuity as collateral to take out a separate loan from a financial institution, like a bank or credit union. This would also avoid penalties, unless you failed to pay back the loan.
Melinda Hill Sineriz has been writing professionally for over 10 years. She worked as an editorial assistant for Forward Movement Publications in Cincinnati, Ohio. She wrote for several years for allmusic.com and edited and wrote a chapter for a book with Wooster Press. She graduated from Miami University in Ohio with a Bachelor of Arts in English. She has a master's degree in teaching.