Deferred Annuity

Deferred annuity is an annuity contract in which the periodic benefits payments do not start right at the end of the accumulation period but is deferred to some future date. A deferred annuity is opposite to an immediate annuity.

Annuities are products offered by insurance companies which are purchased by individuals by paying a one-time single premium or multiple periodic premiums and which entitle them to receive periodic (normally monthly) payments from insurance companies during their retirement period. There are different types of annuities depending on the pattern in which premiums are collected, the time at which the benefits payments commence, whether there is any guarantee of minimum payment, etc.

Deferred annuity vs immediate annuity

Based on the time at which benefits payout starts, annuities are classified into two types: immediate annuity vs deferred annuity. In the immediate annuity, there is no accumulation phase i.e. the time period in which the annuity earns returns i.e. it accumulates value is zero because there is only one premium payments and the benefits payout starts right from the next period. In deferred annuity, on the other hand, after all the premiums are received by the insurance company, there is a time period in which the premiums accumulate interest and there is no payout during that time.

Example

You are a financial consultant and your task is to formulate investment strategy for two of your clients: Mark and Stephen. Mark is turning 60 in one month and has total savings of $450,000. Stephen is 40 years of age and has no savings at all. Both want to have at least $3,000 per month available in their retirement which they want to start when they turn 60.

Mark can consider buying a single premium immediate annuity by paying $450,000 he has in his savings to the insurance company and in return receive a promise of a fixed or variable payment each month for his remaining life.

Stephen on the other hand can enter into an installment premium deferred annuity contract. Such an annuity would require Stephen to pay fixed premium for say initial 10 years. The premium will earn interest during the period in which premiums are deposited and also till Stephen turns 60 after which the monthly payouts will start.

Written by Obaidullah Jan, ACA, CFA and last modified on