The Pros and Cons of Flexible Premium Deferred Annuities

Annuities provide a safe way to grow your retirement savings and earn a guaranteed income in retirement. The top worry of American retirees is that they'll run out of money in retirement. Annuities are designed to solve that problem.

One type of annuity you may have heard of is a flexible premium deferred annuity (FPDA). An FPDA, has many benefits, such as the ability to build savings over time and tax deferral. But along with the many benefits, there are also some drawbacks. FPDA’s are fairly illiquid, there can be substantial fees, and their growth potential is potentially limited compared to other options.

In this article, we break down the pros and cons of FPDAs. We explain what they are, how they work, and their advantages and disadvantages.

What is a Flexible Premium Deferred Annuity?

Annuities are powerful insurance products. They're designed to provide you security in retirement. FPDAs have two main phases: the accumulation phase and the payout phase.

Annuity Stages

The accumulation phase begins when you buy an annuity contract. This is when you pay your premiums to the annuity company. Over time, your premiums earn interest, and your annuity account grows in value.

Later, you can start the payout phase. You typically have several options for payouts. You may choose to receive your payouts in a single lump sum. Or, you can annuitize and convert your annuity into a steady stream of retirement income. With the second option, you can usually choose whether you want annual, quarterly, or monthly payments.

FPDAs have two important characteristics: They have a "flexible premium," and they are "deferred."

With a flexible premium, you fund the annuity in several payments over a period of time. It's the opposite of a single premium annuity, which you fund with a single lump-sum payment.

Deferred annuities grow over several years before they reach the payout phase. That's good because it maximizes earnings. Deferred annuities are the opposite of immediate annuities. Immediate annuities begin to pay you back very soon after you buy them.

How Do FPDAs Work?

You fund flexible premium deferred annuity contracts over time with regular premium payments. They have time to accumulate and earn interest over several years before you turn them into income.

For example, imagine you buy a 5-year fixed FPDA with an initial premium of $10,000 and the interest rate was 3%. And let’s say you fund it with $10,000 a year for the 5 years. Your account value accumulation would look like this:

Year 1: $10,300

Year 2: $20,909

Year 3: $31,836

Year 4: $43,091

Year 5: $54,684

Note that you would have contributed $50,000 in premiums over the 5 years. You would have also earned over $4,500 in interest.

At the end of the term, you could choose to start your annuity payments, or you could roll over into a new annuity.

Types of FPDAs

There are several different types of annuities you can buy within the FPDA category. Three of the most important ones are fixed, variable, and fixed indexed annuities. These differ in how they calculate their crediting rates.

A fixed annuity is an annuity with a fixed minimum interest rate. All Canvas Annuity's products are fixed annuities. They offer a guaranteed minimum crediting rate over the term of the annuity. That means your annuity is guaranteed to grow at the specified rate (as long as you don't make any early withdrawals). This type of annuity is best for individuals who want low-risk, steady growth.

A variable annuity is riskier. When you buy a variable annuity, you select sub-accounts to hold your premiums. These sub-accounts act like mutual funds—they are invested in assets like stocks, bonds, and money market funds.

If those assets do well, you get a higher rate of return on your principal. But if those assets perform poorly, you get a lower rate. You could even lose money. This type of annuity is best for individuals who are comfortable with high risk and are seeking potentially high gains.

Fixed indexed annuities are a blend of the previous two. When you buy a fixed index annuity, you choose a market index like the S&P 500. Your funds are invested following that index. If the index performs well, your interest rate increases. If it performs poorly, your interest rate decreases.

But fixed index annuities also have a fixed minimum interest rate that's usually set at 0%. That means that even if your stock market index does really poorly, your interest rate will never fall below 0%. So you won't lose money due to poor market performance.

In this article, we focus on flexible premium deferred annuities that have a fixed minimum interest rate. These are fixed annuities, and they’re the safest, lowest-risk type of annuity because they offer a guaranteed rate of return.

Flexible Premium Deferred Annuity Pros

Flexible premium deferred annuities have several advantages for retirement planning. Here are the main ones.

1. The Account Value Grows Tax-Deferred

Tax deferral is one of the most important annuity benefits. Tax deferral means that you don't pay taxes on your annuity earnings in the year you earn them. Instead, you pay taxes when you withdraw your funds. That usually happens in retirement. This is a benefit in two ways.

First, because the money sits in your account, it compounds faster. That means your annuity account grows more quickly and earns more.

Second, most people earn less in retirement. That means they usually fall in a lower tax bracket and pay a lower income tax rate. Paying a lower tax rate on your annuity income means you may pay fewer taxes overall.

Note that annuities are not tax-free. You will pay taxes on your annuity income in the year you receive it. Also note that you pay ordinary income taxes on your annuity payments rather than capital gains taxes.

The Tax implications for annuities can be complicated because each person has a different tax situation. For more details, read our article on annuity taxation. You also may wish to consult a tax professional or financial advisor.

2. Guarantees Retirement Income

FPDAs can offer guaranteed lifetime income. An annuity is the only product that offers this. It can provide massive relief if you’re worried about your savings running out in retirement.

3. Death Benefits are Available Many

FPDAs offer death benefits. Death benefits allow the annuitant to name a beneficiary. If the annuitant dies before receiving their entire annuity payouts, the beneficiary receives any remaining funds. This feature makes annuities powerful legacy planning tools.

4. No Contribution Limits

Individual retirement accounts (IRAs) and 401(k)s are two other retirement planning tools. But while these are powerful, they have a significant drawback: There are limits to how much you can contribute each year. Annuities typically don’t have contribution limits. You can fund them with as much money as you like. That's a good thing—it means that you can invest in your future to your heart’s content.

5. Allows for Savings Over Time

A flexible premium annuity lets you fund your annuity over time. That's good if you don't already have a sizable nest egg saved up. Not everyone can afford to purchase an annuity with a large chunk of change at once.

6. Low-Risk Growth with Great Rates

Fixed annuities are one of the safest ways to grow your money. They offer guaranteed minimum crediting rates.

And fixed annuity rates are usually quite high. For example, you can compare them to certificates of deposit (CDs). CDs are also very low risk and have guaranteed minimum rates. But their rates are often significantly lower than fixed annuity rates. And CDs also don't provide guaranteed income.

An annuity offers some of the best growth potential as far as low-risk investment options go.

Flexible Premium Deferred Annuity Cons

As useful as they are, FPDAs aren't for everyone. In this section, we list some of the drawbacks of this type of annuity.

1. Illiquidity

Annuities are long-term investments. One of their biggest drawbacks is that your money is relatively inaccessible. While you can take your money out of a deferred annuity, it can be expensive to do so.

First, the insurance company may levy an early withdrawal penalty called a "surrender charge." You may face this charge if you withdraw from your annuity during the surrender charge period. The surrender charge period is stated in your annuity contract.

Second, the IRS may also charge a tax penalty on early withdrawals. They levy tax penalties on withdrawals from retirement accounts when people withdraw funds before the age of 59½. If you’re younger than that when you withdraw your funds, you may face this tax penalty.

2. Fees and Expenses

Some annuity companies charge substantial fees for their annuities. Variable annuities, in particular, tend to have high fees. But not all companies impose fees. For example, at Canvas, we offer zero commissions, account charges, or fees on our annuities.

3. It Doesn't Pay Back Right Away

Deferred annuities maximize earnings. They give your money time to grow. But the downside is that you need to wait before they pay you back. They're not ideal for someone who wants their annuity payments to begin right away.

Is a Flexible Premium Deferred Annuity Right for You?

The flexible premium deferred annuity can be a fantastic investment. It is ideal for:

• Individuals who want to be able to pay their premiums over time
• Individuals who want to give their annuity premiums time to accrue interest and grow
• Individuals who want to add security to their retirement savings plan

But it may not meet everyone's needs. It's not the best choice for:

• Individuals who want short-term investment options
• Individuals who want to pay their premium in a single lump sum
• Individuals who want their annuity income payments to begin immediately

Flexible Premium Deferred Annuity vs. Single Premium Deferred Annuity

Another common annuity option is the single premium deferred annuity (SPDA).

SPDAs are similar to FPDAs in that they are both deferred annuities. They both give your annuity time to earn interest and grow. Often, your payments start years after you buy them.

The difference is that you fund an SPDA in a single, upfront premium payment. In contrast, you can fund an FPDA over time—often over many years.

SPDAs are great because they are super simple. You fund your annuity in one payment and then watch it grow. When you have a fixed SPDA, you know exactly how much it will earn over time.

In contrast, FPDAs are a little more unpredictable because your growth depends on the value of the premiums you choose to pay over time.

Flexible Premium Deferred Annuities and Canvas Annuity

At Canvas, we offer single premium deferred annuities. You buy our annuities in a single upfront payment. We do not have a flexible premium option.

Instead, we have very low minimums for your initial premiums. You can purchase our Future Fund product for as little as $2,500 or our Flex Fund for just $5,000. That means that they’re accessible to most people, even if you haven’t saved up millions for your retirement—yet!

If you'd like to contribute more to your retirement in the future, it’s easy: just apply for another annuity. You may even choose to purchase several annuities with different terms. This allows you to have some funds accessible in the shorter term while others continue to grow. This is sometimes called a “laddering strategy.”

Think an annuity might be a worthwhile retirement strategy for you? You're in good company. Annuities are popular for a reason. They offer something few other products can: the feeling of financial security in retirement.

If you're interested in learning more about how an annuity can power up your retirement savings growth, get in touch with our licensed representatives. They'd be pleased to explain all the details about how annuities work. And if you think you're ready to get your savings earning more, apply for an annuity online right now! It could be the best retirement decision you ever make.