Deferred annuities are retirement savings structures allowing investors to gain tax-deferred growth with assets that remain in the account. Because deferred annuities are sold by insurance companies, contributions to the account are referred to as premiums. These are supplemental, after-tax contributions that often allow lump-sum, periodic or flexible contributions.
Hearing the term "annuity" can get confusing to investors because there are many variations to them. An annuity is anything designed to create an income stream, whether now or at a future date, according to the Securities and Exchange Commission. Some employer-sponsored retirement plans are called Tax Sheltered Annuities or 403b plans. These work similarly to 401k plans and IRAs with contribution limits, loan provisions and hardship distribution options allowed by the IRS. Contributions in these plans reduce your annual income on a dollar-for-dollar basis. A deferred annuity uses after-tax dollars with earnings growing deferred. When distributions are taken after age 59-1/2, earnings are added to income. Distributions before this age have 10 percent penalty assessed to the earnings.
Buying Deferred Annuities
Most deferred annuities require a minimum initial premium payment of at least $5,000. You can buy a deferred annuity at any age and continue to add to the policy usually until about age 90 when the insurance company requires annuitization -- distribution of the assets based on life expectancy. Insurance companies are flexible with how much and how often you add premiums to the policy, meaning you can add $1,000 one year, $1,800 another and nothing ever again. Each annuity contract has its own minimum addition limits, often $1,000, so read the contract to know how much you need to accumulate before adding more.
Deferred Annuity Types
There is more than one type of variable annuity. There are two fundamental options, fixed and variable, with new hybrids developed based on consumer need. Fixed annuities offer a fixed rate of return for a specified period of time with a regularly scheduled renewal rate. Most fixed annuities guarantee principal deposits. Variable annuities maintain a portfolio of mutual fund options available in the annuity structure so more aggressive investors can create a tax-deferred diversified portfolio. Hybrids such as index annuities offer minimum guarantees while allowing growth potential when stock markets funds are up.
A flexible premium deferred annuity is regulated by state insurance commissioners with variable annuities also being regulated by the Securities and Exchange Commission. Contract terms may be anywhere from one to 15 years with penalties, called surrender charges, assessed to distributions taken prior to the term expiration. Surrender charges may be as high as 25 percent depending on the annuity. Premium payments are flexible, with few limits as to how much you contribute in total to the annuity. Some annuity companies limit contributions to $1 million while others don't. Beneficiaries are named on annuity contracts, avoiding probate hassles and costs.