Deferred Annuities

Everything You Need To Know about Deferred Annuities

(Maybe even a little more)

Jeffrey Green | February 7, 2020
Deferred Annuities

Uncle Sam wants us to save for retirement. That’s why annuities have special features and tax benefits. Where there are tax benefits, there are usually strings attached. Annuities are no exception. 

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So you want to know about deferred annuities? Here’s everything you ever wanted to know, and maybe a little more.

First Things First.. What’s an Annuity?

Annuities are policies issued by insurance companies. They pay a regular guaranteed income for life or a period of years. You buy an annuity policy by making a single payment or a series of payments.

  • Deferred annuities accumulate money for a period of time before the policy pays income.
  • Immediate annuities start paying income right away.
  • Traditional qualified annuities are part of a pension plan or IRA. They are purchased with before-tax dollars. Roth-qualified annuities are part of a Roth IRA or pension. They are purchased with after-tax dollars. Non-qualified annuities are personally owned and paid for with after-tax dollars.

Owners, Annuitants, and Beneficiaries

An annuity policy is a contract between the insurance company and these folks. The owner has the sole right to the values and payments in the contract. The owner decides who the annuitant and beneficiaries are. 

The age and sex of the annuitant are how the insurance company determines how much and when income is paid. The annuitant and owner don't have to be the same. The beneficiary receives the proceeds at the death of the owner or annuitant.

The insurance company issues the policy and has to honor the promises in it. Guarantees in the policy are only as good as the financial ability of the insurance company to pay claims.

What Is a Deferred Annuity?

Deferred annuities have 2 phases. During the accumulation phase, purchase payments made by the owner grow tax-deferred. During the distribution or payout phase, the accumulated money is converted into a stream of guaranteed retirement income.

What Is a Fixed Deferred Annuity?

The values of a fixed annuity are guaranteed by the insurance company. The guarantees apply to:

  • The cash value: Payments accumulated at the interest rates applied
  • The surrender value: The cash value minus any charges for cashing in the policy
  • The annuity payout factors: The rate applied to calculate annuity income
  • Minimum interest rate applied to the cash value

Fixed deferred annuities offer competitive risk-free returns. Fixed annuity interest rates are usually higher than CD or savings account rates.

What Is a Fixed Index Deferred Annuity?

Fixed index annuities have the same features as fixed annuities with one important difference. Fixed index annuities offer tax-deferred growth based on the stock market without stock market risk. Index accounts credit some of the gains of a market index like the S&P 500 and none of the losses.

What Is a Variable Deferred Annuity?

Deferred variable annuities accumulate money in investments selected by the owner called subaccounts. Like mutual funds or other investments, the values of the subaccounts are based on market performance. They aren’t guaranteed. Money can be transferred between subaccounts without any tax consequences.

Variable annuities have features that offer “downside protection” to investors during down markets.

What If the Insurance Company Goes Bankrupt?

Insurance companies that sell fixed annuities are regulated by each of the 50 state insurance departments. These departments have financial standards for licensed companies. Each state has guarantee funds to reimburse policyholders if the insurance company fails. The limits for each state are different.

Financial ratings of insurance companies are available from A.M. Best, Fitch, Moody’s and Standard & Poor.


Highest Ability To
Meet Obligations
Medium Ability To
Meet Obligations
Lowest Ability To
Meet Obligation
s
A.M. BestA++ to A-B++ to B-C++ to C-
Moody’sAaa to AaA to BaaBa to Caa
S&PAAA to ABBB to BCCC to C
FitchAAA to AA-A+ to BBB-BB+ to CC

What Do Deferred Annuities Cost?

  • Front end sales loads: The front end sales load is deducted from your purchase payment. Most products on the market today don’t have a front end sales load.
  • Fees and expenses: Variable annuities have mortality and expense fees, investment management fees and administrative fees.
  • Surrender penalties: Most deferred annuities charge a fee if you cash in your contract, or withdraw more than 10% of the cash value. Surrender penalties decline to 0 over a period of years, usually not more than 10.
  • Market value adjustment: Fixed and fixed index annuities may have market value adjustments during the surrender period.  The market value adjustment will be a cost or a bonus depending on interest rates.
  • Rider fees: Optional riders like living benefits have a cost. The fee is usually a percentage of the cash value.

How Do I Get Income from a Deferred Annuity?

The income from a fixed annuity is determined by the account value and the option that you select. The chart below outlines the options. Once an income option is selected, there is no access to account values.

Guaranteed Income Options


During LifetimeAt DeathAdvantagesDisadvantages
Life Pays income for annuitant’s life.NoneHighest incomeNo refund of unused principle
Life and 10 Years CertainPays income for life. Not less than 10 yearsBalance if death occurs before the end of 10 yearsProtection for beneficiariesLower income
Life and 20 Years CertainPays income for life. Not less than 20 yearsBalance if death occurs before the end of 20 yearsProtection for beneficiariesLower income
Life with Cash RefundPays income for life. Payments are at least the specified refund amount.Balance of refund amountProtection for beneficiariesLower income
Period CertainPays Income for a specified number of years.Balance of paymentsUseful for certain planning purposesOutliving income
Joint & Survivor 100%Pays income for longer of two livesNo further payments at 2nd deathSurviving spouse continues to receive income for life.Lower
income
Guaranteed Lifetime Withdrawal Benefit Single LifePays income for annuitant’s lifeBalance of accountAccess to account values, death benefitIncome taxed as withdrawals
Guaranteed Lifetime Withdrawal Joint LifePays income for lifetimes of annuitant and 2nd lifeBalance of account at 2nd deathAccess to account, death benefitIncome taxed as withdrawals

How Are Deferred Annuities Taxed?

Tax treatment for traditional qualified annuities, Roth-qualified annuities, and non-qualified annuities is different.

The chart below summarizes tax treatment of retirement annuities.


Non-QualifiedQualifiedQualified/Roth 
ContributionsAfter-tax. UnlimitedPre-tax. Limits for RAs and qualified plans apply.Afte-tax. Limits for IRAs and qualified plans apply.
Growth Tax-deferredTax-deferredTax-deferred
Surrender Gain is taxed at ordinary rates.All proceeds taxableTax-free
Annuity Income Partially taxable at ordinary rates100% taxable at ordinary ratesTax-free
Withdrawals Withdrawals are gain first. Gain is taxed at ordinary rates.100% taxable at ordinary ratesTax-Free
Loans Loans are considered withdrawals. Gain first is taxed at ordinary rates.IRA loans not permitted. Pension plans may have exceptions for home purchase and loans repaid in 5 years.IRA loans not permitted. Pension plans may have exceptions for home purchase and loans repaid in 5 years.
Death BenefitsGain is taxed at ordinary rates. Proceeds will be taxed as "gain first."Rules for inherited traditional IRAs and qualified plans apply.Rules for inherited Roth IRAs and plans apply.
Sales Proceeds in excess of basis taxed at ordinary ratesN/AN/A
Penalties10% for withdrawals before age 59-1/210% for withdrawals before age 59-1/210% for withdrawals before age 59-1/2. Penalty for withdrawals prior to  end of the 5th year

What Happens to the Money in a Deferred Annuity When You Die?

If you die during the deferral period, your beneficiary will receive the account value. If you die during the distribution period, the income option that you selected will determine what the beneficiary will receive. 

Optional riders may enhance the death benefit.

Is a Deferred Annuity Right for Me?

Deferred annuities are financial tools. Whether they are right for you depends on the job you want them to do. Here are some considerations:

  • Tax-deferred growth is a major benefit of annuities. Is tax control important to you? Can you benefit from tax-deferred growth?
  • Deferred annuities have surrender and tax penalties. Do you have adequate resources for emergencies and other short-term needs?
  • Deferred annuities can guarantee an income for life. Do you want a fixed guaranteed income for life instead of income that may benefit from market returns?
  • Deferred annuities can offer downside market protections and other benefits. Do these options enhance your retirement plan?

What Should I look for in a Deferred Annuity?

The first concern for any type of annuity is the financial condition of the insurance company. The primary rating services that cover insurance companies are A.M. Best, Moody’s, Standard & Poor, and Fitch. Each has differences in their methodologies and rating designations.

The rating each service assigns reflects their opinion about the insurance company's ability to pay claims. Look for high-quality ratings from at least 2 of the 4.


Highest Ability To
Meet Obligations
Medium Ability To
Meet Obligations
Lowest Ability To
Meet Obligations
A.M. BestA++ to A-B++ to B-C++ to C-
Moody’sAaa to AaA to BaaBa to Caa
S&PAAA to ABBB to BCCC to C
FitchAAA to AA-A+ to BBB-BB+ to CC

Rates on fixed annuities change frequently. Make sure you have a rate comparison from several companies. The surrender period should never be longer than the rate guarantee.

Is it a market value adjustment (MVA) policy? The MVA can have a positive or negative effect if you withdraw money or surrender the policy early.

What Next?

Deferred annuities can be an important part of your retirement plan. While they have many features and benefits, they are not for everyone. Talk to your independent insurance agent. They can help you decide if a deferred annuity is right for you.

Sources © 2020, Consumer Agent Portal, LLC. All rights reserved.

Advisor’s guide to annuities John Olsen

Fundamentals of Investments Wilson & Hopkins

NAIC Buyers guide to deferred annuities

IRS PUB 575

IRS PUB 410

Fitch Ratings Definitions 

Moody’s rating scale and definition

S&P Global Understanding Ratings

A.M. Best Why An A.M. Best Financial Rating Is Important

The American College of Trust and Estate Counsel State Survey of Asset Protection Techniques

© 2020, Consumer Agent Portal, LLC. All rights reserved.

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