The fixed deferred annuity is a solution of the insurance industry to loss protection needs and long
term savings. Annuity holders get interest on their deposited funds just like the owners of liquid
accounts at financial institutions and banks.
In addition to the benefits of ordinary deposit accounts, life insurance coverage is also offered as an added benefit by annuities. Besides this, the funds invested in deferred annuities are free from immediate tax. However, the absence of temporary taxation has a major drawback of illiquidity.
Fixed and variable are two basic categories of annuities. fixed anniuties offer a fixed rate of return
on investment while rate of return on variable annuities fluctuates greatly.
Fixed annuities ensure a guaranteed return for a particular amount of time. In simple words, minimum final investment value is assured to the annuity owner or the policy holder.
Annuities vs. Other Investments
Most of the time, the returns offered by annuities are much better than other investments like money market money accounts or certificate of deposits. This mainly because your money is invested for a longer period of time.
The power of compound interest combined with time makes your ending balance much higher compared to other investment options.
Immediate vs. Deferred Annuities
It is necessary to understand these two sub categories of fixed annuities in order to make quality and well informed decisions.
When you invest in an immediate annuity, you start receiving money shortly after investing. the process of periodic payment continues for a particular amount of time or for your entire life. A continuous cash flow is possible because of the accumulation of interest on the unpaid residual portion of your intial investment.
On the contrary, a deferred annuity rewards the investor after a certain time limit. The investor has to wait for a specific number of years to receive a lump sum or periodic payments after making the initial investment. Due to the accumulation interest over the years, the value of your investment grows substantially to a significant amount.
The common features of an immediate and deferred annuities are as follows:
Guaranteed rate of return and principal preservation
The original value of the investment will never fall except when the insurer becomes insolvent. The investor is assured of a minimum return on investment. Since the investor is assured of receiving a specific amount of money after a specific amount of time, he or she is in a better position to plan financially for the long term.
Just like life insurance policies, annuities feature loss protection which enables the beneficiaries to receive a lump sum amount in case you die. On the contrary, if you have invested in a conventional deposits accounts or CDs, your beneficiaries will only receive the initial investment and the accumulated interest there on.
More Flexible withdrawal options
On maturity of an annuity, the investor can withdraw the whole amount or opt for periodic receipts.
This choice is not offered by any other investment options. The investor can either choose to reinvest the complete amount immediately or accept a lump-sum disbursement to absorb any tax effects.
Advantages of Deferred Annuities
Deferred annuities offer a major benefit in the form of tax deferral. Though you are required to wait for a certain amount of time to receive money, you also get tax relief as your investment grows.
Don't underestimate this great benefit of a fixed deferred annuity. Since the rates of taxes are high, it can take a huge part of your savings. For example, if you are eligible for tax of 35 percent and the return on an annuity is 5 percent, you will be able to realize the full 5 percent return due to tax deferral.
On the other hand, if your returns are taxed immediately, the returns are reduced to 3.25 percent, which is above the yearly US rate of inflation of 3 percent. Thus, when a person whose investments are subjected to immediate tax retires, his or her investments hardly increase in terms of real money.