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have an annuity question?
have an annuity question?

The Immediate Annuity Versus The Deferred Annuity

Perhaps you’re familiar with the famous Marshmallow Experiment conducted by Professor Walter Mischel back in the 1960s. He made a deal with each child, promising two marshmallows if they were able to wait for 15 minutes without eating one marshmallow. What’s interesting is that follow-up studies later confirmed that those children who were able to delay gratification were generally smarter, healthier, and stronger. Waiting can lead to good things, but some needs are immediate. If an income during retirement is what you need, then an annuity might be the right choice. If you’re scratching your head over which type to choose, it might be helpful to boil it down to a simple question of timing. Ask yourself, when do you want your income? Now, or later?

WHAT IS AN IMMEDIATE ANNUITY?

As the name suggests, an immediate annuity can give you an immediate income. It does not grow or accumulate money in the investment vehicle, rather, this is the place where you put the money after it grows. When you choose to roll over a sum of money into an immediate annuity, you typically annuitize that sum of money. This means you make a tradeoff: in exchange for access to that money, you may get a guaranteed income payment. That income payment can be set for a certain period of years (term certain) or it can be set for the rest of your life (life option). Pros: Typically speaking, an immediate annuity can offer some of the highest payment terms for the lowest fees and initial investment amount. The income is guaranteed to be paid out every month; guarantees are based on the claims-paying ability of the insurance company. Immediate annuities can also be guaranteed to provide an income for a single life, or for both yourself and your spouse (ask for a joint-life option). Another benefit is you can set the annuity to payout for a certain period of time, say 20 years, after which any money left over in the account will go to your beneficiaries. Cons: Although simple and cheap, the immediate annuity is not flexible with its terms. It typically does not allow you to access your money: once the lump sum is put into an immediate annuity, the only way to access that money is through the income withdrawals. Biggest Mistake: If you are married and you want your spouse to continue receiving the income payment, make sure you understand the difference between and the primary beneficiary and the joint-life option. If your spouse is listed as the primary beneficiary on the account, they may or may not receive the leftover money upon your death. Selecting the joint-life option means the same regular payments would continue as before, for the rest of your spouse’s life.

WHAT IS A DEFERRED ANNUITY?

As the name suggests, a deferred annuity puts off or postpones the income payout. A typical deferral period is usually 10 years, though it can be more or less. During that time, the deferred annuity is said to be in its accumulation phase. This is when the annuity grows with the goal of additional earnings for additional income. This is also where things get complicated. There are two main types of deferred annuities, and they are named based on the way they each grow the money during the accumulation phase.
  • A variable annuity grows the money using variable investments that can fluctuate in value, going up or down with the market.
  • A fixed-indexed annuity grows the money in a fixed type of account with principal guarantees, earning returns that are based on the performance of a stock market index, such as the S&P 500.
Pros: A deferred annuity can be a more secure place to put the money you need for income if you get the fixed-indexed kind. These types of deferred annuities are designed to give you a way to keep up with the rate of inflation while also protecting your retirement money. Both types of deferred annuities can be structured to give you a lifetime income, although the guarantees of variable and indexed annuities are very different. Also, unlike most immediate annuities, deferred annuities may give you access to up to 10 percent of your money without penalty or surrender fees. Guaranteed Lifetime Withdrawal Benefit (GLWB) riders also allow minimum withdrawals from the invested amount without requiring you to annuitize the investment. Cons: Financial professionals who sell deferred annuities typically earn high commissions. This can make it difficult for the average consumer to figure out which one is best for them. Advisors may be incentivized to sell you a particular annuity that may not be in your best interest, or they may only have access to one type of annuity. The National Adult Protective Services Association (NAPSA) has listed variable annuity sales practices as one of their top threats to investors because variable annuities are also one of the most expensive types of annuities that you can own. Biggest Mistake: Both variable and fixed-indexed annuities offer income riders for which they charge a fee somewhere in the neighborhood of 1 or 2 percent. The income rider is an added feature that adds another layer of complication to an already complex choice, particularly with variable annuities. Oftentimes, the income rider is sold at a guaranteed rate of return rather than what it really is: a separate account used by the insurance company to calculate your income payments. If you don’t need an income from the investment, or are more than 10 years away from retirement, than this feature may be a waste of your money. (If you think you may be in this type of annuity, please reach out to one of our advisors so we can have it tested for you.) The immediate or deferred annuity: which is best? While we at Annuity Gator like to ask this question, the answer really depends on what you’re looking for, as well as what works best for your situation. We hope this comparison has been helpful and made you aware of a few annuity traps. If there is still a question in your mind, feel free to reach out to one of our retirement planning experts. We’d be happy to get back to you, no strings or fees attached, promise! Get Smart: 3 Investor Tips To Raise Your Retirement IQ

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