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Deferred Annuity

Addition to term insurance, savings plans and investment plans, life insurance companies in India also offer annuity plans. These plans provide you with a stable and guaranteed1 source of income regularly at the frequency chosen by you. Depending on when these annuity payouts begin, there are two types of annuity plans that you can opt for — immediate annuity and deferred annuity plans.

So are you looking for an avenue to create a retirement corpus and a regular income stream for your retirement days?

Investing in a deferred annuity might be the right choice. You can have a stress-free retired life and accomplish everything on your bucket list without worrying about finances.

Read on for more information about the deferred annuity meaning its features, types and benefits.

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deferred annuity

Deferred Annuity: Feature, Types & Benefits

Deferred Annuity: Feature, Types & Benefits
November 05, 2024

Table of Content

What is Deferred Annuity?

A deferred annuity plan is an investment tool designed especially for the retirees. It serves as an income replacement and provides a fixed and regular income stream from a future date as per your choice. Under this life insurance plan, you can set aside a part of your income during your career days for your post-retirement requirements.

The corpus created can fulfil your retirement goals like going on a world tour, a dream home, investing in a business, etc.

How do Deferred Annuities Work?

After understanding the deferred annuity meaning, you should also know how it works. A deferred annuity is a means of regular income post-retirement. In a regular annuity, you can choose to pay a premium for a predecided period, after which you get immediate income without any waiting period.

The payout can be for a certain period or a lifetime, depending on the plan.  The insurance company will give you an idea of the regular amount you will receive depending on the balance and the chosen payment option. The longer the period, the lower will be the income.

If you can afford to invest a large amount at one go, you can choose the single premium payment option where you pay the entire premium upfront and start receiving income after a waiting period also referred to as deferred payment. Premium paying flexibility i.e., monthly, quarterly, half-yearly, yearly, or single payment is available depending on the plan opted for.

The accumulation phase makes a deferred annuity plan different from immediate annuities. Only a single premium payment option is available in immediate annuity plans and the returns are much lower. Assess your financial goals and your retirement requirements before investing in annuity plans.

Types of Deferred Annuities

Various annuity plans are designed to align with the investor’s retirement goals, needs, and risk tolerance. Some of them are discussed below:

  • Fixed Deferred Annuity

A fixed deferred annuity is similar to a fixed deposit. The interest rate is fixed, and the annuity payout is the same throughout the payment period. The returns are pre-decided while purchasing the annuity and are not linked to market risk. Though the returns are lower, they are guaranteed.

This low-risk retirement plan is ideal for risk-averse individuals and those who prefer investments with capital protection. The income stream is predictable and stable in this type of annuity.

  • Variable Deferred Annuity

Investors ready to risk their investments opt for variable deferred annuity even after knowing that the returns are variable. The premiums paid are invested in various market-related assets like mutual funds, equity, bonds, shares, stocks, etc.

The returns are higher if the assets perform well and lower if the performance is poor.

Variable deferred annuities are investment instruments that allow investors to earn better returns in comparison to a fixed deferred annuity but involve market-related risk. The annuitants can diversify their portfolio based on their risk appetite.

  • Indexed Deferred Annuity

An indexed deferred annuity provides an opportunity for investors to earn more returns than a fixed deferred annuity. The yields however depend on the equity or stock index performance.

During years when the stock index declines, the insurance company provides a minimum return on the investment. When the market performance is good, the gains are high. However, the provisions in the contract, like participation rates and rate caps, limit the yield on the investment.

  • Longevity Annuity

A longevity annuity is designed to provide income at a future date and is usually offered around the retirement age. The purpose is to avoid outliving retirement savings.

For a lump sum payment under this plan, the investor receives a guaranteed monthly payout for life from a pre-determined future date.

The Investor has no access to the amount and will receive the payout only if he/she is alive on the payout date. If the investor dies before the payout date, the beneficiary does not receive any amount unless the investor has purchased an optional death benefit.

Owing to these conditions, they receive higher returns compared to any conventional immediate annuities. The returns are lowered if the investor changes the payout date.

Advantages of Deferred Annuity

Now that you know what is deferred annuity and the types of deferred annuity plans, you should also understand the benefits you derive from the investment tool. The advantages are:

  • Various Payout Options

Deferred annuity offers various payout options. You can receive a lump sum payment. This option is beneficial for those who seek immediate cash. You can also opt for a lifetime payout option, which ensures that you do not outlive your retirement savings.

In the fixed-period payout option, you can choose a payout for a certain period to accomplish specific financial objectives. A joint-and-survivor option is also available wherein both you and your spouse get the payout and have financial security during the retirement period.

  • Payment Delays

Payment delays in deferred annuity plans end up giving the benefit of accumulation of funds. The payout is not immediate but on a pre-determined future date. The accumulated funds grow over time, and the value increases. Longer delays allow more time for the investment to compound, and the income payouts will be larger.

This facility, in a deferred annuity plan, helps individuals plan for a steady income when their other sources of income stop or are reduced, providing them with a financial cushion during challenging times.

  • Easy Fund Additions to Deferred Annuities

Individuals who prefer to invest small amounts over a period benefit from easy fund additions to deferred annuities. This option allows the investors to contribute small amounts regularly to gradually build a retirement corpus instead of a lump sum amount in one go.

The premium can be fixed according to the investor’s financial situation and to suit his/her pocket. This feature reduces the financial burden and is convenient to increase the annuity value for larger future payouts.

  • Easy Withdrawal of Funds from Deferred Annuities

Most deferred annuities permit withdrawal of funds before annuitisation but with some restrictions. The purpose of a deferred annuity is to be a long-term part of your retirement income plan.

Hence, insurance companies discourage the withdrawal of funds before the surrender period by imposing high surrender charges. This feature is beneficial in case of emergency fund requirements.

By understanding the withdrawal conditions, the surrender period in the contract, etc., and carefully planning withdrawals, you can preserve the long-term value of retirement savings.

Disadvantages of a Deferred Annuity

Being aware of what is deferred annuity is not adequate, you should also know the downsides associated with the investment vehicle before buying one. Some of the disadvantages of a deferred annuity pension plan are:

  • Complexity

The different types of deferred annuity plans like a flexible annuity, variable annuity, indexed annuity, etc., can confuse a customer. The features of the annuity plans vary with different insurance companies and understanding them can be overwhelming.

Also, comprehending the different terms like participation rate, surrender fee, mortality and expense fee, can be difficult. These complexities can lead to buying a deferred annuity that does not align with your requirements and goals.

  • High Fees

Fees for deferred annuities are generally high and can potentially reduce investment growth. The various fees charged for deferred annuity are administrative costs, surrender charges (for withdrawal before annuitisation), mortality and expenses fees, etc.

Apart from these fees variable annuities include investment management fees. High fees are a great disadvantage for those seeking cost-effective retirement savings.

  • Illiquid

It can be difficult to access your funds in deferred annuity before the surrender period which typically is six to eight years from the date of purchase. You are charged high surrender fees that can erode the returns on your investment.

  • Fees For Early Withdrawal

If you withdraw the funds before completing 59 ½ years of age, you will have to forego the tax deferral benefits. Additionally, you will incur a 10% penalty for early withdrawal of the amount. This can reduce the value of your long-term retirement savings.

Who Should Think About Getting a Deferred Annuity?

A deferred annuity is suitable for anyone seeking a regular income stream when their income source ceases. However, there are cons attached to a deferred annuity as well.

Those reaching retirement age and need a fixed income stream can invest a part of their assets in a deferred annuity plan. Choosing the right plan depends on each one’s risk tolerance and post-retirement goals.

A fixed annuity offers lower returns than other types of annuity plans but the returns are guaranteed and the capital is protected. When combined with a pension, a fixed annuity gives sufficient financial security for retirees.

Individuals willing to take risks for better returns can contemplate investing in variable annuities. The returns depend on the market performance. They are high when the performance is good and low when the performance is poor. With a diversified portfolio, the annuitants can balance their returns.

Persons interested in reducing their tax burden while creating a source of income for their future goals can invest in deferred annuities. The premiums paid towards the annuities are eligible for tax deductions under Section 80C of the Income Tax Act 19612.

Summary

A deferred annuity is a great investment tool for anyone intending to create a regular income stream for post-retirement needs. Despite downsides like heavy fees, surrender period, huge penalties for early withdrawal, etc., this is a popular retirement investment tool. The reason is the convenience of contributing small amounts over a period for tax-deferred income at a future date.

FAQs on Deferred Annuity

Q: What do you mean by deferred annuity?

Deferred annuity is a life insurance plan meant for retirement. It allows you to contribute small amounts during your working days to get a fixed income at a future date you choose.

Q: What is the deferred annuity formula?

The deferred annuity formula is P × [1 – (1 + r)-n] / [(1 + r)t-1 × r] where P is annuity payment, r is the interest rate, n is the number of periodic payments, and t is the period of delay.

Q: What is the difference between an ordinary annuity and a deferred annuity?

The main difference between an ordinary annuity and a deferred annuity is when the payouts begin. In ordinary annuities, the payment is at the end of a period. It could be monthly or yearly like pension payments, rental payments, etc. In deferred annuities, payments begin from a future date chosen by the annuity purchaser.

Q: What are examples of deferred annuities?

The best example of deferred annuities is retirement plans. The investor contributes during working days to receive a fixed income after retirement, which could be after decades. Meanwhile, the accumulated funds earn interest to render higher payouts.

Q: How does a payout annuity differ from a deferred annuity?

In payout annuity you receive immediate income after a lump sum is invested. In a deferred annuity the payouts are on a pre-decided future date allowing the investment to earn interest during the deferral period before the payout commences.

Related Articles

Reference links:

1. https://www.forbes.com/advisor/retirement/deferred-annuity/

2. https://cleartax.in/glossary/annuity

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Francis Rodrigues Francis Rodrigues

Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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Vishal Subharwal heads the Strategy, Marketing, E-Commerce, Digital Business & Sustainability initiatives at HDFC Life. He is responsible for crafting and ensuring successful implementation of the overall organisation strategy.

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