Deferred AnnuitiesSource: IRS.gov
An annuity is a contract between an individual and an insurance company under which, in return for receiving a sum of money from the individual, the insurer agrees to pay a steady income to the annuitant-the person who is to benefit from the annuity. The annuitant may or may not be the owner-the person who enters into the contract and makes payments into the annuity. A deferred annuity is one that will begin making payments sometime in the future. Deferred annuity premiums must be paid in cash, and may take the form of: - single-premium deferred annuity, or
- A flexible-premium deferred annuity
A single-premium deferred annuity requires the owner to fund the annuity with a single substantial payment. The actual amount depends on the amount of income desired to be paid in the future. This type of annuity is often purchased by someone who has received or accumulated a large sum of money, such as an inheritance, the death benefit from a life insurance policy, a bank CD that has matured, or a retirement distribution. A flexible-premium deferred annuity allows the owner to make smaller periodic payments over the life of the annuity until such time as the annuitant will begin receiving income. Because the premium is flexible, the amount the owner pays may vary within limits established by the issuing insurer. Each premium payment may be increased or decreased if the owner's circumstances so warrant. Of course, if a specific amount of income is desired, attention must be given to the amount of premium required to purchase that future income. Insurers deposit annuity premiums into their general accounts and pay interest at current market rates. The insurance company may guarantee a current rate for a certain period, after which the rate is adjusted based on market conditions. Typically, a guaranteed minimum interest rate is specified, and will be used in the event current rates fall very low. The interest paid on the annuity is left in the account to accumulate along with the premium payments. Taxes are deferred on the interest paid during the accumulation period as long as the funds are not withdrawn. The same tax treatment applies to both single-premium and flexible-premium deferred annuities. The advantage of the single-premium annuity is that there is immediately a large sum of money that begins to draw interest, resulting in more significant growth over the accumulation period. With the flexible-premium annuity, the amount earning interest grows more gradually as individual premiums are added to the account. Because the most common purpose of an annuity is to accumulate retirement funds, an annuity should be considered a long-term proposition. To encourage owners to leave the annuity intact for a long period, insurers often assess a surrender charge if withdrawals are made early in the life of the annuity. After a specified period-possibly five years or more-the insurance company typically allows partial withdrawals of up to 10 or 15% annually of the total amount on deposit without charging a surrender fee. The federal government, however, is not so generous. If the annuitant makes a withdrawal before reaching age 59 1/2, the IRS requires a 10% penalty tax as well as immediate taxation of the taxable portion of the withdrawal. This applies to both partial and complete withdrawals, but no tax penalty is assessed under these limited circumstances: - The owner/annuitant dies;
- The owner/annuitant becomes disabled; or
- The withdrawal is paid out as part of a series of substantially equal periodic payments made, usually, for the life or life expectancy of the owner/annuitant, or for the joint lives or joint life expectancies of the owner/annuitant and a beneficiary.
Of course, regular income tax is still payable on the gain. When the time comes for the annuitant to begin receiving income from the annuity, a number of options are available for how the income will be paid. These settlement options further define the annuity. They are: - Straight-life or life-only annuity - Payments cease when the annuitant dies, even if the entire investment in the annuity has not been paid out. This option is rarely selected since most people want to recoup the entire amount by leaving it to a beneficiary if the annuitant dies early.
- Joint-life annuity - Typically there are two annuitants (although there may be more) and payments stop when either one dies. This option is used in cases where additional income is required for two people, but the single survivor does not require the additional income.
- Joint-and-last-survivor annuity - Annuity payments are made until the death of the last annuitant. Sometimes, a reduced payment (often two-thirds or one-half) is made after the first annuitant dies, reflecting a smaller income need to support the second person.
- Period-certain annuity - Income will be paid for a specified period of time until funds are exhausted. The amount of each payment is determined by the length of the period and the amount available in the annuity at the beginning of the payout.
- Amount-certain annuity - A specified amount will be paid regularly to the annuitant. The length of time that amount will be paid depends on the amount available in the annuity at the start and the amount of each payment.
- Refund annuity - Offered in different forms, these annuities agree that if the annuitant dies before fully receiving the income, the insurer will provide either a continuation of the income or a lump-sum settlement to a named beneficiary.
Most annuities include a beneficiary designation providing that any funds left if the annuitant dies before receiving them will be paid to a beneficiary. Variations of each type of annuity described previously may be available. The annuities described here are called fixed annuities because they are credited with a specified or "fixed" rate of interest. Certain features of the payout are also fixed. Another type of annuity is the variable annuity. | 
