Annuities may not be as familiar as 401(k)s, IRAs, or brokerage accounts, but they can play a role in some retirement income strategies. Understanding immediate vs. deferred annuities is a helpful place to start.
An annuity is a contract with an insurance company. In exchange for a premium or a series of premiums, the insurance company agrees to make payments according to the terms of the contract. Depending on the annuity, those payments may begin right away or at a later date.
At True North Wealth Management, we help clients evaluate whether an annuity fits their income needs, tax picture, liquidity needs, and long-term retirement strategy.
Two Basic Phases
Many annuities involve two phases: accumulation and payout.
During the accumulation phase, the money inside the annuity has the potential to grow tax deferred. That means taxes on earnings are generally delayed until money is withdrawn.
During the payout phase, the annuity begins making payments. Those payments may be structured for a set number of years, for life, or based on other contract options.
The tax treatment depends on the type of annuity, how it was funded, and how payments are received.
Immediate Annuities
An immediate annuity is designed to provide income soon after purchase.
A person typically pays a lump sum premium to the insurance company. In return, the insurance company begins making regular payments, often within one year.
Immediate annuities may appeal to retirees who want to convert part of their savings into a predictable income stream. Payments may continue for a set period, for life, or for the life of the annuity owner and a spouse, depending on the contract.
Part of each payment may represent a return of principal, while part may represent taxable earnings. The exact tax treatment depends on whether the annuity was purchased with pre-tax or after-tax dollars.
Deferred Annuities
A deferred annuity delays income until a future date.
During the accumulation period, the contract value may earn interest or investment returns depending on the type of annuity. Payments can begin later, often in retirement.
Deferred annuities may appeal to individuals who want tax-deferred growth, future income options, or a way to set aside additional retirement assets outside traditional contribution limits.
However, deferred annuities are usually not as liquid as a bank or brokerage account. Many contracts include surrender charges if money is withdrawn during the early years.
Important Costs and Limitations
Annuities can provide useful benefits, but they also come with costs and restrictions.
Depending on the contract, fees may include:
- Administrative charges
- Mortality and expense charges
- Investment management fees
- Rider charges
- Surrender charges
- Contract fees
Withdrawals and income payments are generally taxed as ordinary income. If money is withdrawn before age 59½, a 10% federal tax penalty may apply to the taxable portion unless an exception applies.
Annuity guarantees depend on the claims-paying ability of the issuing insurance company. Annuities are not guaranteed by the FDIC or any other government agency.
Read the Contract Carefully
Variable annuities and some other annuity products can be complex.
Variable annuities are sold by prospectus. The prospectus explains the investment objectives, risks, charges, and expenses. Variable annuity values can fluctuate based on market conditions and may be worth more or less than the original amount invested if surrendered.
Before purchasing any annuity, review the contract, fees, surrender period, income options, beneficiary provisions, and tax treatment.
Which Type May Fit?
An immediate annuity may fit someone who wants income now. A deferred annuity may fit someone who wants to delay income until a future date.
Neither choice is automatically better.
The right fit depends on:
- Retirement income needs
- Cash reserves
- Investment assets
- Tax situation
- Health and longevity expectations
- Desire for guaranteed income
- Liquidity needs
- Legacy goals
- Comfort with contract limitations
Annuities in a Broader Retirement Plan
Annuities can offer attractive features for some retirement-minded investors, including tax deferral and potential income guarantees. They can also include costs, surrender periods, and restrictions that should be weighed carefully.
At True North Wealth Management, we help clients compare annuity options with other retirement income tools and determine how each choice fits into the broader plan.
An annuity should support your retirement goals—not complicate them.
Related Reading
- Insurance Needs Assessment for Married Couples With Children
- Insurance Needs Assessment for Empty Nesters and Retirees
- How Insurance Deductibles Work
- Learn about our goal-based financial planning services
Important Disclosures:
This material is for informational purposes only and is not intended as tax, legal, accounting, insurance, annuity, or individualized investment advice. Annuities are insurance contracts and may include fees, expenses, surrender charges, tax consequences, liquidity limits, and investment risk. Withdrawals and income payments may be taxed as ordinary income, and withdrawals before age 59½ may be subject to a 10% federal tax penalty unless an exception applies. Guarantees depend on the claims-paying ability of the issuing insurance company. Variable annuities are sold by prospectus and may lose value. Consult qualified tax, legal, insurance, and financial professionals regarding your circumstances.
FINRA notes that annuities are often marketed for retirement and tax-deferred savings but can include surrender charges, administrative fees, mortality and expense charges, and other costs. The IRS explains that annuity withdrawals before age 59½ may be subject to the additional tax on early distributions, depending on the taxable portion and whether an exception applies.
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite and customized by True North Wealth Management LLC to provide information on a topic that may be of interest. FMG Suite is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright FMG Suite.