Deferred Payment Annuity

What Is a Deferred Payment Annuity?

The term deferred payment annuity refers to an insurance product that provides future payments to the buyer rather than an immediate stream of income. It allows the investment's principal balance to grow both by contributions or premiums and interest before payments are initiated to the owner of the annuity.

Annuity owners can choose how often they receive income and for how long. Some of these annuities also pay death benefits to survivors or other beneficiaries if the owner dies during or after the accumulation phase.

How a Deferred Payment Annuity Works

An annuity is a financial contract that allows the buyer to make a lump-sum payment, or a series of payments, in exchange for receiving future periodic disbursements. Annuities range from fixed to variable and immediate to deferred. A deferred payment annuity, which is also known as a deferred annuity or a delayed annuity, is different from other annuities in how premiums are paid and when it comes to withdrawals.

This kind of annuity may be funded through monthly contributions. Some investors may prefer making a lump sum contribution, possibly even decades before payments start. Withdrawals do not begin soon after it is funded, as with an immediate annuity. A deferred payment annuity grows during the accumulation (or deferral) phase and dispenses benefit payments in the distribution (or income) phase.

These annuities typically offer tax-deferred growth at a fixed or variable rate of return, just like regular annuities. Earnings are taxed as ordinary income upon withdrawal. They may be purchased for minor children who begin receiving benefits payments when they turn 18 or another age specified by the annuity buyer. 

A deferred payment annuity buyer need not ever turn the money in the annuity into a series of income payments. Money may be withdrawn as needed, in a lump-sum payment, or transferred to another account or annuity. When a deferred payment annuity is used this way, the annuity buyer retains control of their money, rather than being locked into payments by initiating a withdrawal in a distribution or annuitization phase.

Most companies that offer these kinds of annuities do not permit changes to the contract after the initial period has passed.

Special Considerations

If you're wondering what happens to your account if you die, it's important to ask the company and review the annuity contract before signing up. Companies that offer annuities may not be required to pay benefits to survivors if the owner dies during or after the accumulation phase.

Some insurance companies offer death benefits for some or all of the annuity's value to the owner's beneficiary(s). If you want to be sure that your family or other beneficiaries receive money from your annuity in the event of your death, be sure there's a death benefit within your contract.

Types of Deferred Payment Annuities

As noted above, there are a number of types of deferred payment annuities. We've noted just a few of the most common ones below.

Fixed Delayed Annuity

A fixed delayed annuity, which is more commonly known as a fixed deferred annuity, works just like a certificate of deposit (CD). Interest rates on a CD are fixed during the entire term of the investments but they tend to vary due to market conditions. Any interest income earned is taxed the same year that it's accumulated.

Rates for a fixed delayed annuity work a little differently. Interest rates tend to be guaranteed for a specific period of time, after which they are adjusted on an annual basis. Tax on the interest is deferred until withdrawal for a fixed delayed annuity. The annuity writer typically specifies what guaranteed interest rate the annuity will pay.

Variable Delayed Annuity

Buying a variable delayed annuity isn't any different than buying a mutual fund. Returns on both types of investments depend on the performance of a group of sub-accounts. Owners can decide how their premiums are invested, including in fixed-income accounts that offer a minimum interest rate that is guaranteed. Although the potential for a higher payout is possible, these annuities can be riskier and more expensive than other deferred annuities.

Longevity Annuity

A longevity annuity works like a normal life annuity. It is also called a deferred income annuity. It tends to start much later than the typical retirement age. It acts like longevity insurance in that payments may not start until a retiree's other assets are spent down. The annuity owner deposits a premium payment at the time of purchase but they don't receive any income until a specified date in the future.

Income payments are based on several factors, including the total amount of the premium, the date the income is expected to be received, the owner's age, and their life expectancy. Changes in market conditions don't affect the amount of income the annuity owner receives.