Immediate vs. Deferred Annuities: What Are the Differences?

There is a popular candy called “Now & Later.” The product is so good, they say, that you’ll want to have some now and save some for later! Interestingly, annuities have the same attributes.

Annuities are retirement tools that allow retirement-minded investors to build retirement savings tax-deferred now and then receive that money as a regular paycheck at a specific date later in retirement.

Most other savings products, like one of the many types of CDs and savings accounts, require you to pay taxes on income every year. And no other retirement savings product can guarantee you a paycheck for the rest of your life.

Deferred annuities are typically purchased before you retire.

Deferred in the title “deferred annuity” refers to when you receive your money. You pay a premium to the insurance company today but payments back to you are deferred until a later date. In the meantime, your money earns interest.

Deferred annuities also share something in common with all annuities in that they grow tax-deferred meaning taxes owed on the principal and/or earnings are deferred until you begin receiving payouts.

Just as the word deferred in the term deferred annuities means you receive a future payout, the term immediate in an immediate annuity means you receive a payout almost as soon as you purchase the product.

When you purchase an immediate annuity, you pay a premium to an insurance company and your lifetime income payments (or payments for a period of time chosen by you) begin immediately. This product is purchased when you are nearing, or in, retirement and can provide regular income and peace of mind.

Let’s explore in more detail the role of each of these products and distinct phases of annuities as part of your overall financial plan.

Deferred Annuities

Utilizing a deferred annuity to support your retirement is relatively simple. To start, you choose a provider and pick a type of annuity based on your risk tolerance (more on that later). Then you deposit an initial premium and watch your money grow (side note: it’s nice to choose a company with an easy-to-use online portal where you can actually watch as your account value grows).

Deferred annuities can be an effective vehicle to use if you have bumped into contribution limits that are associated with IRAs. You can deposit money in a one-time lump sum (a single premium annuity) or transfer smaller amounts over months or years (a flexible premium annuity).

Deferred annuities are generally used to build value during what is known as the accumulation phase.

When you’re ready to begin receiving regular income, you let the company know that you would like to annuitize the contract. They will provide you with payout options along with a statement of annuity of the monthly or annual income payments you can expect.

Types of Deferred Annuities

Deferred annuities are typically classified based on returns, term, and funding style.

Annuity Types by Return

Interest rates are credited based on the type of annuity you select. The three types are:

• Variable
• Fixed
• Fixed-indexed

The type of annuity you select should be driven by your investment objectives and risk tolerance.

Fixed Annuities

A fixed-deferred annuity may be the safest option. They are sometimes compared to bank certificates of deposit (CD). The interest rate is guaranteed for the period of time you select. Fixed annuities offer very competitive rates compared to CDs and savings accounts.

Guaranteed returns make fixed annuities a solid foundation upon which to layer riskier retirement products. Because they are not bank products, annuities are not insured by the FDIC but are instead backed by the financial strength of the issuing insurance company.

Variable Deferred Annuities

Variable annuity contracts have no guaranteed rate of return. With this product, you invest your money in “subaccounts,” which are similar to mutual funds.

These variable annuity subaccounts hold assets like stocks, bonds, and money market accounts that can offer significant upside vs fixed annuities.

However, they can also lose money. If the investments you choose do well, your annuity balance grows and can enhance your future payouts. If your investments underperform, your balance will not grow as much and may even shrink, reducing any potential future payouts.

You take on more risk with variable deferred annuities, and there are often mortality fees and investment management fees associated with their purchase and upkeep. But variable annuities also offer greater upside potential.

Be sure to ask a financial professional about these costs and other administrative fees before purchasing a variable annuity.

Fixed-Indexed Annuities

Fixed-indexed deferred annuities (also known as index annuities) feature attributes of their fixed and variable counterparts. Returns for this type of annuity are based on a compilation of funds known as an “index.” One such index is called the S&P 500.

So when the stock market goes up, your money grows and if it declines, your returns will suffer.

The good news is that indexed annuities set minimum returns, usually at 0%, so even if the index declines, you will not earn less than 0%. Let’s do a quick comparison.

Let’s say you purchase a fixed, fixed-indexed, and variable annuity at the same time.

And let’s say the fixed annuity guarantees a 2% crediting rate during a year in which the market losses 5% overall (for this example, we’ll just tie crediting rate to the market and not a specific index).

At the end of the year, your fixed annuity will have earned 2%, your fixed-indexed annuity will have earned 0%, and your variable annuity will have lost 5% plus the management fees you paid. Alternatively, if the market rises by 5%, you would be better off in either the fixed indexed annuity or the variable annuity.

Some people can afford to take this gamble with their retirement savings, but many people can’t. That’s why the steady, guaranteed returns of a fixed annuity are so attractive to so many.

Annuity Types by Funding

Single-Premium Deferred Annuities

With a single-premium deferred annuity, you pay for the contract with one lump sum payment. This could be a large deposit from your savings or a transfer or rollover from a retirement plan, like a 401(k).

Flexible-Premium Deferred Annuities

With flexible-premium deferred annuities, you pay for the contract over time with a series of premiums. The more premium payments you make into the contract, the greater your future income. This type of annuity is helpful if you don’t have a single, large sum to use to fund an annuity.

Taxes and Withdrawals

The tax treatment of deferred annuities works a lot like individual retirement accounts (IRAs) and 401(k)s. As long as your money is in the annuity, you won’t owe any annual income taxes on your gains. You only owe those taxes when you start collecting income. The way deferred annuities are taxed is one of their greatest advantages.

This tax-deferral feature can help you grow your savings more quickly than if you use a regular brokerage account, where gains are taxed yearly as ordinary income. Deferred annuities are best used as a long-term investment.

Immediate Annuities

As mentioned earlier, immediate annuities allow the annuity holder to receive income payments almost immediately after making a lump sum payment to the insurance company. When you buy an immediate annuity, you receive guaranteed income payments for a set number of years — or possibly for the rest of your life. An immediate annuity can be viewed as a “do it yourself” pension.

Since corporate pension plans have been on the decline over the past 20 years, this product could fit the bill as a replacement. This income guarantee makes an immediate annuity worth exploring as an ”anchor” for your retirement income and tax strategy.

Because of the guarantees of an annuity contract, a retiree can afford to be a little more adventurous with other investments in their portfolio like stocks, bonds, and mutual funds. The primary downside is that once you purchase the annuity, it cannot be withdrawn except by receiving the payment stipulated in the contract.

This general lack of liquidity means it’s best not to invest all of your retirement assets in an immediate annuity contract.

There are many types of immediate annuity contracts featuring a wide range of attractive features and fees.

Types of Immediate Annuities

There are a handful of distinctions between the types of immediate annuities that are important to know. Some are based on the level of returns that they can generate. Like deferred annuities, immediate annuity rates of return are classified one of three ways — variable, fixed, and indexed.

These products are further classified by how long the income payments last: either for a set period of time or for the account holder's life. Here’s what each of those classifications means and who might benefit most from each kind of immediate annuity.

Annuity Types by Term

Variable Immediate Annuities

Returns on variable immediate annuities are driven by investment accounts selected by the contract holder. You deposit a certain amount, and what you earn is based on the market conditions and the performance of the underlying investments. If your selected investments do well, the current income payout increases. But if the investments perform poorly, your income payments may decrease. And, like the deferred version of this product, beware of fees.

Fixed Immediate Annuities

Fixed immediate annuities are great if you are looking to remove risk from investing in the annuity. The insurance company guarantees a set rate of return that will not change during the term you select. Just remember that because your rate of return is fixed, inflation can reduce the value of your funds.

Your returns in a fixed immediate annuity will also be lower than they might otherwise be if you used an annuity whose returns were at least somewhat based on market returns. That said, for retirement-minded individuals who need a set amount of income and can’t risk any losses, a fixed annuity is a good choice.

Indexed Immediate Annuities

Indexed immediate annuities, also known as fixed indexed annuities, have features of both variable and fixed annuities. Your income payments are tied to a market index, like the S&P 500. When the index does well, you receive a larger payment, and when the index doesn’t do well, you receive less. An indexed immediate annuity puts caps on potential gains and a floor on losses.

Annuity Types by Payout Options

Term (Period Certain) Immediate Annuities

With a term immediate annuity (or period certain), your income payments will last for a set period of time. The time periods generally are from five to 20 years, and you can choose an interval that works for you. If you die during the term, the annuity will generally continue making those scheduled payments to your selected heir(s). Once the term ends, though, the payments stop, even if you’re still alive.

Lifetime Immediate Annuities

A lifetime immediate annuity means that retirement income payments will last for your entire life, but payments stop at the end of the annuitant’s life (or the surviving spouse’s life in the event of a joint life annuity).

Single life annuities are best for healthier individuals or for people who are not married since the payouts are higher. Joint life annuities can work well if you want to make sure that the surviving spouse still receives income payments.

Comparing the Two Options

Deferred annuities are designed to allow you to earn interest now prior to retirement and build a nest egg in preparation for retirement. Immediate annuities are products perfect for when you are in or nearing retirement and need to generate income right away in the form of a monthly paycheck. You may want to seek real-life advice from tax professionals and other experts as you decide which product strategy might be best for your individual situation.

Deferred vs. Immediate Payouts

Deferred annuities generate income that is free from tax obligation until the money is paid out to you sometime in the future. Immediate annuity payouts start right away, usually within the first year of depositing a lump sum of money with the insurance company.

Deferred vs. Immediate Rates

Rates for both deferred and immediate annuities can vary depending on the type of annuity you purchase. Rates of return are driven by fixed, fixed-indexed, or variable choices.

Immediate vs. Deferred Risk Factors

The risk factors of annuities, both deferred and immediate, are linked to the type of return choices selected by the buyer. Fixed rates of return have the least risk. Variable rates have the most risk.

Differences in Policy Rider

Availability Riders are optional benefits usually attached to an annuity as guaranteed minimum living benefits and guaranteed minimum death benefits. Adding riders to annuities always comes with a cost, generally reflected in lower rates of return.

Are there Other Options to Consider?

Besides deferred and immediate annuities, there may be other products to consider that fit a specific role in your retirement planning.

One of those products is called a Qualified Longevity Annuity Contract, or QLAC. These products defer annuity payments until a future payout date later in life to pay bills that are incurred as you grow older.

Which is Right for You: Deferred or Immediate Annuities?

Deferred annuities are generally purchased earlier in life and are designed to allow you to accumulate assets on a tax-deferred basis. If you are looking to diversify your investment portfolio, deferred annuities can play an important role.

Deferred annuities can also be used as an income source in retirement when you are ready for regular monthly income. If you are close to, or in, retirement, immediate annuities can create a monthly paycheck right away, giving you peace of mind your basic living expenses can be paid for.

For the more complex versions of these products (i.e., variable and fixed indexed) don't depend on general information.

You may want to get detailed information on product features by asking for a prospectus and by consulting financial or accounting professionals for advice.

Choosing a Deferred Annuity with Canvas Annuity

If a deferred annuity sounds like a good fit, then a Canvas annuity can be a great option.

Canvas Annuity is a convenient, smart choice for lots of reasons: they have some of the top rates in the country on fixed annuities, you can purchase completely online which saves you time and effort, plus they have a great online portal where you can watch your money grow.

Contact one of our licensed representatives today to learn more.