# Understanding Deferred Annuities: Types and How They Work for Your Future Income

## What Is a Deferred Annuity?

A deferred annuity is a contract with an insurance company, offering a future stream of income or a lump sum. Unlike immediate annuities, these contracts defer payments to a future date, providing tax-deferred growth. Let's explore the various types, including fixed, indexed, and variable annuities, and how they benefit long-term financial planning.

### Key Takeaways

*   A deferred annuity is an insurance contract that provides income at a future date after an accumulation period.  
    
*   There are three main types of deferred annuities: fixed, indexed, and variable, each offering different methods of return.  
    
*   Withdrawals from a deferred annuity before age 59½ may incur a 10% tax penalty in addition to regular income taxes.  
    
*   Deferred annuities grow on a tax-deferred basis, which can be advantageous for long-term investment goals.  
    
*   Deferred annuities can have high fees and surrender charges, making them less liquid compared to other investments.

## Understanding How Deferred Annuities Operate

There are three basic types of deferred annuities: fixed, indexed, and variable. As their name implies, [fixed annuities](https://www.investopedia.com/terms/f/fixedannuity.asp) promise a specific, [guaranteed rate of return](https://www.investopedia.com/ask/answers/092815/what-are-risks-annuities-recession.asp) on the money in the account. [Indexed annuities](https://www.investopedia.com/terms/i/indexedannuity.asp) provide a return that is based on the performance of a particular market index, such as the S&P 500. The return on [variable annuities](https://www.investopedia.com/terms/v/variableannuity.asp) is based on the performance of a portfolio of mutual funds, or sub-accounts, chosen by the annuity owner.

All three types of deferred annuities grow on a tax-deferred basis.

The time when investors contribute to the annuity is the accumulation phase. Once the investor elects to start receiving income, the [payout phase](https://www.investopedia.com/terms/p/payoutphase.asp) (or income phase) begins. Many deferred annuities are structured to provide income for the rest of the owner's life and sometimes for their spouse's life as well.

> **Warning**
>
> Buyers should ensure they have sufficient emergency funds before purchasing an annuity.

## What Are the Disadvantages of a Deferred Annuity?

Prospective buyers should also be aware that annuities often have high fees compared to other types of retirement investments, including surrender charges. They are also complex and sometimes difficult to understand.

Most annuity contracts put strict limits on withdrawals, such as allowing just one per year. Withdrawals may also be subject to [surrender fees](https://www.investopedia.com/terms/s/surrenderfee.asp) charged by the insurer. In addition, if the account holder is under age 59½, they will generally face a 10% tax penalty on the amount of the withdrawal. That's on top of the income tax they have to pay on the withdrawal.

## Is an Annuity Considered a Liquid Asset?

Deferred annuities should be considered long-term investments.

Annuities' [liquidity](https://www.investopedia.com/terms/l/liquidity.asp) varies based on the surrender charges laid out in the insurance contract. The surrender period is when you would need to pay a hefty fee to exit the contract—certainly something you'd want to avoid. [The surrender charge—for example, 10%—declines over time until it arrives at zero](https://www.investopedia.com/terms/s/surrendercharge.asp). These surrender periods can last several years, even 15 years. During this time, most people would consider their investment to be illiquid.

However, once the surrender period has passed, the annuity becomes more liquid, relatively speaking. They may be considered to be more liquid than an asset that you must find a buyer for, such as a [car](https://www.investopedia.com/how-to-sell-a-car-5119440) or a [home](https://www.investopedia.com/costs-of-selling-home-5210656). But they are still less liquid than, for example, [mutual funds](https://www.investopedia.com/terms/m/mutualfund.asp) purchased outside of an annuity.

## What Happens to an Annuity After Death?

Deferred annuities often include a [death benefit](https://www.investopedia.com/terms/d/deathbenefit.asp) component. If the owner dies while the annuity is still in its accumulation (savings) phase, their [heirs](https://www.investopedia.com/terms/h/heir.asp) may receive some or all of the account's value. If the annuity has entered the payout (income) phase, however, the insurer may simply keep the remaining money unless the contract includes a provision to keep paying benefits to the owner's heirs for a certain number of years.

## Do You Pay Taxes on a Deferred Annuity?

Owners of these insurance contracts pay taxes only when they make withdrawals, take a lump sum, or begin receiving income from the account. At that point, the money they receive is taxed at their ordinary income tax rate.

## The Bottom Line

Deferred annuities can be a useful tool for supplementing retirement income sources like Social Security. They offer a structured source of income in retirement but come with complexities. Consider their high fees and illiquidity when determining if they fit into your retirement strategy. Always ensure you have other liquid resources available. It’s crucial to weigh the benefits against the limitations before incorporating them into your financial plan.

> **Article Sources**
>
> 1.  Financial Industry Regulatory Authority (FINRA). "[Annuities](https://www.finra.org/investors/investing/investment-products/annuities#types)."
>     
> 2.  Internal Revenue Service. "[Topic No. 558 Additional Tax on Early Distributions From Retirement Plans Other Than IRAs](https://www.irs.gov/taxtopics/tc558)."
>     
> 3.  Investor.gov. "[Surrender Charge](https://www.investor.gov/introduction-investing/investing-basics/glossary/surrender-charge)."