A deferred annuity allows your savings to grow tax-deferred, ultimately creating a reliable income stream for your retirement years. 

Read on to learn what a deferred annuity is and why it might be the right choice for your financial goals.

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What’s a deferred annuity?

A deferred annuity is an insurance product designed to increase your savings over time. These insurance contracts allow your funds to grow tax-free for a specified duration. After the defined period, your provider allows you to converts your funds into guaranteed income payments during retirement or make a lump sum withdrawal.

A deferred structure lets you build a stable financial foundation for retirement while benefiting from potential growth during the accumulation phase. Note, though, that if you withdraw funds before the age of 59½, you may face an IRS 10% tax penalty; and if you are within your surrender period the insurance company may charge you a surrender penalty and/or market value adjustment.

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How does a deferred annuity work?

Deferred annuities operate in two main phases — the accumulation phase and the payout phase. Here’s a basic breakdown of each:

• Accumulation phase: During this period, you contribute money to the annuity through a lump-sum payment or periodic contributions. The funds grow tax-deferred, meaning you won't pay taxes on any earnings until you start withdrawing funds. 
• Payout phase: This phase begins when you decide to start receiving income from your annuity. You can accept payments as a lump sum or in regular installments over time.

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5 types of deferred annuities

Deferred annuities come in various forms, each catering to different investment strategies and risk tolerances. Here are the five primary types of deferred annuities available.

1. Fixed deferred annuity

A deferred fixed annuity offers a guaranteed interest rate on your deposit for a specific time period. Although the interest rate may be lower than potential market returns, the certainty of the guaranteed interest rate lets you know exactly how much money you'll have for retirement. 

Fixed annuities are an excellent choice if you prioritize stability and want to let your savings grow, even if only modestly, without jeopardizing your future income.

2. Variable deferred annuity

A variable deferred annuity lets you to select one or more subaccounts to allocate your deposit. Variable annuities carry risks, but they also have the potential to achieve greater market returns based on market performance. 

Your account balance grows if your subaccounts perform well, leading to a higher future payout. Alternatively, if your subaccounts underperform, your account value may not increase as anticipated and could even decrease, resulting in a lower payout, or no payout at all. 

3. Indexed deferred annuity 

An indexed deferred annuity combines features of both fixed and variable contracts. It guarantees you won’t lose your deposit an also offers the potential for growth. A fixed index annuity is designed to provide growth potential based on the returns of a market index (e.g., the S&P 500^® Index) while providing protection against negative returns of the same market index. With a fixed index annuity, you don’t invest directly in the market, instead the money you allocate to a selected index can is credited interest based on the market index it tracks.

4. Single premium deferred annuity

A single premium deferred annuity lets you make a one-time lump-sum payment to secure future income. You can use this option if you receive a large sum and wish to create a reliable income stream without making monthly contributions.

5. Flexible premium deferred annuity

With a flexible premium annuity, you can make multiple contributions over time rather than committing to one large payment. This adaptability lets you adjust your investments according to changing financial situations.

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Benefits of deferred annuities

Investing in a deferred annuity comes with the following advantages:

• Tax-deferred growth: Your earnings accumulate without being taxed until withdrawal, allowing your investment to grow more efficiently than in taxable accounts.
• Guaranteed income: Some deferred annuities provide guaranteed interest rates for your earnings, so you have the funds needed to cover critical expenses like housing and healthcare.
• Death benefits: Deferred annuities often include death benefits, guaranteeing your beneficiaries will receive at least the amount you invested if you pass away before you receive payments.
• Unlimited contributions: There are generally no limits on how much you can contribute to a deferred annuity, making it an excellent option for maximizing your retirement savings.
• Flexibility: Deferred annuities offer various payout options and customization features, so you can tailor your contract to your financial goals.
• Protection from market volatility: Fixed and indexed deferred annuities protect against market downturns, ensuring your principal investment remains secure while offering growth potential.
• Additional riders: Many insurance companies provide extra features called annuity riders that can improve your contract, such as guaranteed income benefits or long-term care coverage.

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Potential disadvantages of deferred annuities

While deferred annuities offer many benefits, it’s wise to consider the following potential drawbacks before committing to a contract:

• Early withdrawal penalties: Withdrawals made before age 59½ are subject to a 10% IRS tax penalty which can reduce your overall returns if you need access to your funds early.
• High fees: Deferred annuities typically have considerable fees, including administrative and commission charges. These costs can eat into your investment returns over time, so make sure you understand all the fees associated with buying an annuity.
• Limited liquidity: Due to the penalties associated with early withdrawal, some people find access to funds from a deferred annuity too restricted. This lack of liquidity might not satisfy everyone's financial requirements.
• Product complexity: The wide variety of options and features available with deferred annuities may be overwhelming. Understanding all terms and conditions requires careful consideration and potentially professional advice.

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How do interest earnings accumulate in a deferred annuity?

In a deferred annuity, your income grows tax-free, meaning you can benefit from compounding interest. Here’s a quick summary of how some annuity types accumulate earnings: 

• Fixed annuity: A fixed deferred annuity guarantees a specific interest rate— over a set period. This rate provides consistent and predictable growth, regardless of market fluctuations. As time passes, compounding interest comes into play, allowing you to earn interest on both your initial investment and previously accumulated interest. 
• Variable annuity: A variable annuity subjects your deposit to market risk. Since returns fluctuate with market trends, they’re not guaranteed. While this type of annuity offers growth potential, it also carries a higher level of risk. Gains can compound as you reinvest them, providing substantial growth during a rising market — but that value can decrease significantly during market downturns.
• Indexed annuity: This type tracks a specific index like the S&P 500, and the interest you are credited depends on how that index performs. Generally, there’s a cap on returns and a guaranteed minimum, letting you benefit from market gains while having some protection against losses. Compounding enhances your balance as you reinvest profits. 

Compounding occurs when you add the interest you earn back to your principal balance, meaning you earn interest on a larger balance over time. It creates a snowball effect that boosts your annuity, especially if you leave the account untouched. The more often interest compounds — daily, monthly, or yearly — the faster your account can grow, maximizing its long-term potential.

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Annual Percentage Yield (APY) rates are subject to change at any time.

All guarantees are based on the financial strength and claims-paying ability of the issuing insurance company. 

SteadyPace^TM is issued by Gainbridge Life Insurance Company (Zionsville, Indiana.)