The Pros & Cons of a Single Premium Deferred Annuity

A single premium deferred annuity is an insurance policy that functions as a long-term savings contract. This annuity policy accepts a single premium payment to fund the contract forever and the insurance company reinvests the money into fixed interest products or mutual funds, depending on the annuity. The investment returns are allowed to grow, tax deferred, until annuitization when payments begin. Make sure you understand both the pros and cons of this type of annuity before you invest in one, though.

Money in an annuity is not taxed until you start taking payments at retirement. Your policy's annuity receives favorable tax treatment as long as all money remains in the annuity. You do not have to remove this money during your lifetime, so this money may be passed on to your family if you wish. Even better, a investment returns are added to your policy, they benefit from compounding. This means that your accumulated interest also earns interest, adding to the account the growth each year.

There are no contribution limits on annuities. This makes them excellent additions to your retirement savings plan at work or your Individual Retirement Account. These traditional retirement plans have restrictions on how much money may be contributed to the policy. With an annuity, there are no such restrictions so you may save as much as you need for retirement.

Withdrawals from an annuity are taxed at ordinary income tax rates in the year the payment is made. The taxed portion of the annuity is the gains. Contributions are not taxed twice. However, contributions are not tax-deductible. This means that you have less money to begin investing with and less money during retirement due the taxation of the gains.

Annuities normally come with surrender penalties. These penalties are designed to encourage you to keep the policy for a long period of time. However, the policy's surrender period may extend for many years (e.g., 10 years). If you need the money in the contract during this time, you may not be able to get at it without paying a penalty. The insurer may allow a free withdrawal of 10 or 20 percent, though the company is not obligated to make this part of the contract. Surrender penalties act to limit your access to the savings in the contract and may substantially reduce the amount of money you have available for retirement if you are not out of the surrender period but need to make withdrawals.