Deferred Annuity: Meaning, Types, Benefits and How it Works

A deferred annuity plan allows the insured to accumulate a significant amount of money as an annuity in exchange for a one-time or recurring payment. Such plans aid in saving money for retirement by creating a stable source of income. It is a popular long-term savings plan which provides guaranteed earnings, especially for senior citizens. 

What Is a Deferred Annuity Plan?

It is a type of insurance contract whose main aim is to provide stable and guaranteed earnings at a deferred date, usually after retirement. You can invest in a deferred annuity plan in one go or make small fixed recurring payments. 

You will also receive a certain interest on the invested amount, which varies from one plan to another. The income stream generated from these annuity plans can be delayed at a later date as per your preference. 

These annuity plans also provide an option for early withdrawal in cases of emergencies. However, you will have to pay fees and penalties for withdrawing from a particular annuity plan. 

How Does Deferred Annuity Work?

In simple words, a deferred annuity plan eventually turns your premium deposits into a set number of payments at a later date. You can either invest a lump-sum amount in a deferred annuity plan or pay in recurring instalments. 

The insurance company will invest the amount in different arenas as per the objectives of annuity plans. You can start receiving regular payments after a period of time. You can delay these payments until your retirement starts and enjoy regular earnings during that time. 

Moreover, you can set the timeline for receiving these payments as per your requirements. For example, you can set a term for 15 years or the rest of your life. However, it must be noted that the longer the timeline for receiving these payments, the smaller amounts you will receive. 

The insurance company offering deferred annuity plans may provide a specific return on the amount invested or guarantee a minimum pay-out to insured individuals. In addition, some insurance companies may also provide annuity plans where on death of the annuitant, annuity is paid to the spouse during his/her life time and purchase price is returned to the nominee after the death of the spouse. The treatment of the annuity plan depends on the annuity option exercised by the policyholder while buying the plan..  

There are different kinds of annuities available. First, we will discuss types of deferred annuity plans based on returns

Also Read: What are Fixed Annuities & How Do They Work?

Types of Deferred Annuities Based on Returns 

• Fixed Deferred Annuity

It is one of the safest annuity plans available for investment. You will receive a minimum guaranteed yield or payout from annuity providers. The total amount that you will receive is decided in advance when entering into the plan. 

The payout you receive might increase in future depending on the increase in interest rates. However, insurance companies cannot reduce the amount which you will receive. Interest rates on these plans are lower than other annuities, but it provides you with a stable income source. 

Therefore, individuals who have a low risk appetite and are only looking for a stable income may prefer this annuity plan. One drawback of this plan is that it is not immune to inflationary trends.

• Variable Deferred Annuity

As the name suggests, these annuity plans do not come with fixed interest payments, unlike fixed annuities. Amount invested in variable deferred annuity plans remains locked in an investment account. Thereafter, the amount gets invested as per your age, risk tolerance level, and other factors. 

Investments are made in stocks or bonds. The return on these plans is dynamic and depends on the performance of underlying securities. It may outperform or underperform other annuity plans and may not be suitable for people having  low-risk appetites. Due to flexible interest rates, it may act as a hedge against inflation.

• Index Deferred Annuity 

Also known as equity-indexed annuity plans, interest received on these is tied to an index like Nifty50 and Sensex. Returns on index annuity depend on the performance of markets; if markets perform poorly, you will receive lower returns. On the other hand, if markets rise, you can earn a significant return.    

One significant advantage of this annuity plan is that the insurance providers set a limit on the maximum gains and losses incurred. Therefore, you are eligible for a guaranteed minimum amount. It provides dual benefits of fixed income and high return potential, and you can enjoy the dual characteristics of fixed and variable annuity plans. 

Also Read: Annuity Plans: Definition, Types, and Tax Treatment

Types of Deferred Annuities Based on Term

Here are the primary types of term-based deferred annuities:

• Term Deferred Annuities 

Under this plan, you will receive payments in term annuities for a set time period. For example, you will receive regular income for a period of 5 years, 10 years or 20 years as per your preferences. If you die before the term ends, your authorised nominees will continue receiving the income for the remaining period. 

However, you are not eligible for any additional payments if you are alive and the payment term ends.

• Lifetime Deferred Annuity

In lifelong annuities, you can receive payments for the rest of your life, and it acts as lifelong insurance. This way, it secures your entire retirement life, and you can maintain a decent standard of living. 

However, you will receive the annuity only till you are alive. In case of your sudden demise, the payments will stop even though you have not recovered the entire sum invested. Moreover, in lifetime annuity plans, the insurance company expects to make payments for an extended period; therefore, monthly earnings are minimal. 

Types of Deferred Annuities Based on Funding

Deferred annuity plans based on funding are as follows: 

• Flexible-premium Deferred Annuities 

As the name suggests, you can invest small amounts of money in these annuity plans periodically. The future income depends on what you are paying; the more you pay, the larger will be your future payout . 

• Single-premium Deferred Annuities 

Under the single premium annuity plan, you can pay a lump sum amount upfront, which can be your savings or the amount received as an inheritance. As this plan entails a large deposit, it may not be an ideal plan for salaried individuals. 

Benefits of Investing in Deferred Annuity Plan

Some advantages of investing in deferred annuity plans are as follows: 

• Multiple pay-out options 

There are different pay-out options available for your selection. You can choose to cover your or your dependent’s lifespan or both, as the case may be. 

• Guaranteed retirement income

A deferred annuity plan helps you to build a retirement corpus that can financially secure the later stages of your and your dependent’s life. You can easily cover necessary medical expenses and enjoy a decent standard of living. 

These plans are a great way of supplementing other retirement benefits, such as pensions. It also gives you peace of mind as you are confident of financial security after retirement. 

• No maximum contribution

There is no restriction on the maximum contribution an individual can make to these plans. You can contribute as much as you want according to your financial capabilities. In this way, you can create a large corpus and receive higher income in future. 

• Tax deferred gains 

One of the biggest advantages of deferred annuities is that it helps you save on tax. The earnings from this tax savings account shall not be taxable till you start withdrawing them. If you invest money that has already been taxed, there will be no additional taxation on earnings. 

Drawbacks of Investing in Deferred Annuity Plans

Here are some drawbacks of investing in deferred annuity plans: 

• High Costs

A deferred annuity plan may levy high costs and fees on individuals for providing a guaranteed income. The high costs may reduce net earnings from these investment plans. Therefore, you should do thorough market research and select an annuity plan which comes with low fees. 

• Low Liquidity

These plans are associated with poor liquidity. It is difficult to withdraw prematurely from these schemes as you might have to incur high surrender charges and penalties. Once you start receiving regular income from these, you wouldn’t be able to withdraw the entire amount in one go. 

• Complexity

The complexity associated with these insurance contracts is a major drawback that does not allow individuals to take complete advantage of the same. It will be best if individuals contact a trusted financial advisor who will guide them with its intricacies. 

Final Word

A deferred annuity plan allows you to have a secured financial life during retirement. As there are many annuities available in the market with varying tenures and annuitized periods, you should do thorough research and clearly understand the nitty-gritty of a plan before making any investments. 

Frequently Asked Questions about Deferred Annuity