Deferred annuity vs. immediate annuity: Comparing the differences

Approaching retirement can come with a range of emotions. You may feel gratitude and joy as you reflect on what you've accomplished for yourself and your family—but you also may feel uncertainty. As the market and economy fluctuate, it's natural to wonder if you'll have enough money to last the rest of your life.

Annuities can help add security to your retirement plan, and there are several types to consider. Before deciding if an annuity might fit into your retirement plan, it helps to understand the differences between two major categories: deferred annuities vs. immediate annuities.

We’ll cover:

• What is a deferred annuity?
• What is an immediate annuity?
• Main differences between deferred vs immediate annuities
• A comparison chart of deferred vs immediate annuities

A deferred annuity is an insurance contract that helps provide retirement income over a specified period of time in exchange for a lump-sum or ongoing premium payments. Depending on how far away from retirement you are, you can defer your income stream until later to give your investment time to grow during an accumulation period.

More commonly, payouts are set to start when or after you expect to retire.

An immediate annuity is an insurance contract funded by a single lump-sum payment for a fixed payout in the near-term. You decide on the frequency and duration of your payouts when you buy it.

Your payouts can start in as early as 30 days but must be taken within the first year. This aspect makes it an ideal option if you're nearing or already in retirement and want to set up an income stream right away.

These two types of annuities differ in significant ways. Consider what distinguishes a deferred annuity from an immediate annuity as you explore the right retirement strategy for you.

Payment options for immediate annuities are more limited than deferred annuities.

Immediate annuities must be funded with an upfront, single premium that typically comes from retirement accounts, such as a 401(k) or IRA. It does not have the option for ongoing premium payments to fund the account.

With a deferred annuity, you have the option to fund it with a single lump sum at the start or pay premiums over a period of time. Making regular payments could put less of a strain on your budget than tying up a big chunk of your money at once.

As their names suggest, a key difference between immediate and deferred annuities is the timing of when payouts begin.

Immediate annuities usually must start paying out within 12 months of purchase. This near-term period tends to benefit people who are approaching or already in retirement and want to close gaps in their income stream to alleviate concerns they'll outlive their retirement savings.

While deferred annuities can start paying out as early as a year after purchase, they also allow payout dates that start years or even decades later. Having a long-term accumulation phase can make a deferred annuity an attractive option if you have plenty of time before retirement to build potential earnings growth.

The accumulation period of deferred annuities typically offer more opportunity for tax-deferred growth potential. However, the earning potential will depend on the type of annuity you choose.

Generally, an immediate annuity has less time to gain earnings because there is no accumulation period and the payouts start much sooner. But if your priority is a consistent income stream right away that reflects more growth potential than most savings accounts, an immediate annuity could meet your needs.

Deferred annuities can give you the security of fixed payouts later that are based on the accumulated growth. Types of deferred annuities include:

• Fixed deferred annuities: These annuities ensure that your principal can't lose value due to market losses, which makes them attractive for those who are in or near retirement. Learn more about the three types of fixed deferred annuities.

• Variable deferred annuities: These offer greater growth potential and a larger degree of risk. You'll select investment subaccounts based on your financial goals and risk tolerance. Your annuity’s value will fluctuate daily based on the performance of the subaccounts you select. You have greater growth potential than a fixed annuity but a greater chance of loss if your subaccounts drop in value.

• Deferred income annuities: Provides you with preset payments that begin at a specified point in time that you select at the time of application—typically between two and 30 years away. These annuities involve neither specified fixed nor variable rates of return for you. Instead, you pay the premium, and after the allotted period of time, the insurer makes payments of a fixed amount back to you. They have the potential to exceed what you paid in since the payments are guaranteed for as long as you live.

Immediate and deferred annuities offer tax-advantages that may help you stay tax-efficient in retirement.

Depending on the type of immediate annuity you choose and whether you're funding the annuity with non-qualified dollars, such as from a pension, only a portion of your annuity income is taxable. This may help reduce your tax bill in retirement and continue to defer taxes on part of your retirement savings.

With deferred annuities, any earnings received during the accumulation phase grow tax-deferred. (However, with a variable annuity, which is tied to investment subaccounts, growth is not guaranteed.) You won't pay income taxes on your annuity gains until you receive the payouts, which helps the earnings to compound over time.

If you're concerned about supporting your family after your death, annuities might be a reliable way to help ensure their care after you're gone.

Most immediate annuities give you the opportunity to include a death benefit in your contract. If you opt for a guaranteed payment period and die before it concludes, your beneficiaries will receive the remainder of your scheduled payouts.

A deferred annuity typically has a death benefit where the insurance company will return at least the premiums you paid (less any partial surrenders) to your beneficiaries if you pass away before your annuity’s value is depleted. Once you elect an annuity payout, the death benefit will depend on the option you selected.

When it comes to financial security and taking care of your family, there's no one-size-fits-all approach. A deferred annuity can fit into your plan if you're a few years from retirement and want to leave an inheritance. Immediate annuities could be the better option if you need to cover your living expenses in retirement or simply want a predictable income.

Deciding between a deferred annuity vs. an immediate annuity involves weighing a lot of factors that are specific to your circumstances. An experienced professional can help you understand your best options based on your risk tolerance, time horizon, needs and goals. Connect with a Thrivent financial advisor to discuss how an immediate or deferred annuity may fit into your retirement plan.