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What is a deferred annuity & how does it work?

Man and woman having discussion over a digital tablet
Man and woman having discussion over a digital tablet
ALTO IMAGES/ALTO IMAGES / Stocksy United

The bottom line:

• Deferred annuities are designed to build income for your retirement through tax-deferred growth potential.
• Deferred annuities can be purchased in a lump sum or through individual payments (contribution limits apply).
• Deferred annuities are available in fixed and variable to match your risk tolerance.

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What is a deferred annuity?

A deferred annuity is commonly used to generate a steady stream of income in retirement. Funded by a large, one-time payment or in smaller amounts over months or years, a deferred annuity provides you with flexibility and an opportunity for growth. Payments from your deferred annuity can begin one year after you’ve opened it or later.

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How does a deferred annuity work?

Annuities are designed to build income for your retirement through tax deferred growth potential. The interest earned in a deferred annuity is not taxed until you withdraw it.

As long as your money stays in the annuity, you don't owe taxes on your gains. You only owe taxes when you start collecting income. It can help you grow your savings more quickly than if you use a regular brokerage account, whose earnings you must pay taxes on yearly.

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What are the benefits of a deferred annuity?

Since deferred annuities aren’t returned to you in the form of steady retirement income for some time, they can grow during the accumulation phase. But that’s just the beginning. There are many other benefits to purchasing a deferred annuity, including:

Builds income for retirement

With a deferred annuity, you build your savings today for a retirement income tomorrow to supplement your pension or Social Security. It can provide a consistent income flow to help cover essential expenses like groceries or utilities during retirement.

Investment flexibility

With a range of deferred annuity types available, you can choose an investment approach that best aligns with your goals and risk tolerance.

Tax savings potential

Deferred annuities allow you to defer taxes until you receive payments.

Extra rider benefits

Additional features, known as riders, allow you to purchase extra benefits with your contract.

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Are there any disadvantages to deferred annuities?

The disadvantages of deferred annuities are that they may not be liquid, early withdrawal taxes may apply, the fees may be high and the structure can be complex.

Reduces your cash liquidity

Once you sign up for a deferred annuity, you may not have immediate access to all of your money if you need it for emergencies. And it can be expensive to withdraw your principal investment earlier than planned.

Early withdrawal taxes

As part of deferred annuities' tax benefits, the IRS wants you to keep your money in these accounts until you retire. If you withdraw a large sum or cancel your contract before you turn 59½, you could owe a 10% early withdrawal penalty on top of income taxes on your gains.

Potentially high fees

A deferred annuity could charge high fees in exchange for income and investment guarantees. Make sure you understand the costs of an annuity before you commit to the contract.

Complicated structure

Contracts for deferred annuities can be complex surrounding guarantees, fees and terms. You should consult with a trusted financial advisor before purchasing a deferred annuity.

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Should you add a 'rider' to your deferred annuity?

While annuities come with several great benefits, they may not have everything you’re looking for. Companies may offer a variety of riders to customize your annuity to fit your needs. There are fees involved with adding riders, so you should always discuss these options with a financial professional before purchasing your contract.

A few of the popular riders available today include:

  • Death benefit rider: Gives you the ability to designate death benefits to your heirs.
  • Lifetime income benefit rider: Guarantees you’ll receive regular income payments for the rest of your life, even if your annuity is fully depleted.
  • Cost of living (COLA) rider: Based on inflation, it provides increases in your monthly payments.
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Which types of deferred annuities are available?

The types of deferred annuities are single premium deferred annuity (SPDA), flexible premium deferred annuity, fixed deferred annuity, variable annuity and index deferred annuities. These annuities are classified by their terms, returns, and funding.

1. Single premium deferred annuity

A single premium deferred annuity (SPDA) is established with a single lump-sum payment with the potential for investment growth during the accumulation phase. Investment growth occurs on a tax-deferred basis until regular payments begin. These annuities can be either fixed or variable.

2. Flexible premium deferred annuity

This type of annuity lets you fund it in multiple installments rather than one large premium payment. When you choose the contract, you make the first payment, then additional payments at your own pace, without a set schedule. Making multiple payments can help you build up a more significant amount over time.

3. Fixed deferred annuity

Fixed is the simplest type of deferred annuity to understand. The insurance company gives you a guaranteed fixed interest rate on your investment when you agree to the length of the guarantee period. That interest rate could last anywhere between a year and the entire length of your guarantee period.

Because fixed annuities are based on a guaranteed interest rate and your income is not impacted by market volatility, you will know exactly how much your monthly payments will be – but the contract also won't benefit from a potential upswing in the market, and it may not keep pace with inflation.

Read more: What is a fixed annuity & how does it work?

4. Variable deferred annuity

A variable deferred annuity allows you to invest your money into subaccounts, which over time can help you keep up with or even outpace inflation. However, subaccounts are dependent on market risk and performance and could lose value. For this reason, variable annuities often offer a death benefit or an optional income rider for an additional fee, which can guarantee income to your beneficiaries. A variable annuity can be a great addition to your retirement income plan if you've already maxed out your Roth IRA or 401(k) contributions.

Read more: How variable annuities work: The facts & myths.

5. Index deferred annuities

With an index deferred annuity, returns are based on a market index, such as the S&P 500. An index annuity limits the highest possible gain and highest possible loss, providing some unpredictability (but not as much as a variable annuity).

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What’s the difference between a deferred and immediate annuity?

The terms "deferred" and "immediate" refer to when the actual distribution of your annuity begins. A deferred annuity is funded with a lump sum or payments over time (called an accumulation period). Payout begins on a future date. An immediate annuity starts paying when you deposit a lump sum or in the first 12 months following its purchase.

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Can you lose money with a deferred annuity?

Once you purchase your annuity, there may be hefty fees involved with withdrawing your money early. Early withdrawals (before age 59½), for example, can result in a 10% penalty paid to the IRS on the amount of the gain withdrawn, in addition to your regular income tax. Early withdrawals can carry surrender charges owed to your financial institution, as well. If you purchase a deferred variable annuity, your annuity could lose value based on the performance of your investment options. It's essential to read your contract documents to learn what's true for your deferred annuity contract.

In addition, as with any financial decision, it's essential to get good financial advice to ensure the deferred fixed or variable annuity you choose offers:

  • The income payments you want to supplement your Social Security or pension plan
  • A level of investment risk you're comfortable with to support retirement goals
  • Additional options/riders for features important to you, such as survivor payments to your spouse or favorite charity

It's also possible to lose money in a deferred annuity if the organization you choose dissolves. Or if it is unable to pay its obligations when you retire. Help reduce this possibility by selecting an organization with a strong rating. Look at reports from A.M. Best, Fitch, Moody's or Standard & Poor's.

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When should you buy a deferred annuity?

If you decide that you want an annuity, the time to buy one is generally when you’re in your late 50s or early 60s and looking forward to retiring in the next decade or so. A deferred annuity can help supply you with additional income to live comfortably in retirement. And since it can be funded in a lump sum or through a series of payments, it may help you build a more significant nest egg and generate income for the rest of your life.

To learn more about how deferred annuities can help you reach your retirement goals, connect with a financial advisor near you.

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This webpage provides general annuities information. It does not contain information specific to a Thrivent financial product. If you are looking for information specific to a Thrivent financial product or your existing annuity contract, please log in and refer to your contract or prospectus document—or visit our annuities product webpage.
Annuities are intended to be long term, particularly for retirement. Product availability and features may vary by state.

Surrenders or partial withdrawals/surrenders may be subject to income taxes and/or surrender charges. Withdrawals made prior to the age of 59½ may be subject to a 10% federal tax penalty.

Guarantees based on the financial strength and claims paying ability of Thrivent.

Holding an annuity inside a tax-qualified plan does not provide any additional tax benefits.

Refer to the Thrivent Investment Management Inc. Form CRS Relationship Summary for more information about us; our relationships and services; fees, costs, conflicts, and standard of conduct; disciplinary history; and additional information. Refer to the Thrivent Investment Management Inc. Regulation Best Interest Disclosure document for information on fees, products, services, potential conflicts of interest, and additional information. Both are available upon request from your financial advisor or professional and on thrivent.com/disclosures.

Investing involves risk, including the possible loss of principal. The product prospectus, portfolios' prospectuses and summary prospectuses contain more complete information on investment objectives, risks, charges and expenses along with other information, which investors should read carefully and consider before investing. Available at thrivent.com.

Thrivent and its financial professionals do not provide legal, accounting or tax advice. Consult your attorney or tax professional.

Riders are optional and available for an additional cost.

Thrivent financial advisors and professionals have general knowledge of the Social Security tenets. For complete details on your situation, contact the Social Security Administration.

Concepts presented are intended for educational purposes. This information should not be considered investment advice or a recommendation of any particular security, strategy, or product.

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