If someone wants to purchase an annuity but does not have a lump sum payment available, they may want to consider a flexible premium deferred annuity.
There are different types of annuities, such as immediate or deferred. Immediate annuities could begin making payments within a year of purchase, while deferred annuities typically don’t start to provide payments for at least a year.
The money used to purchase an annuity is known as a premium. The two main options for annuity premiums are single, meaning a one-time lump-sum payment is made, or flexible, meaning there are several payments made over time.
So, a flexible premium deferred annuity is an annuity that will be paid into incrementally over time and payments are deferred until a later date.
If a flexible premium deferred annuity sounds like it may be a good fit for someone, here is some more context into how they work and what should be considered before recommending purchasing one.
How Do Deferred Annuities Work?
Immediate annuities are always single premium annuities because they are purchased with a lump sum and begin paying out immediately. Deferred annuities, on the other hand, typically offer more options; they can be purchased with a lump sum or with multiple payments. This means the client can purchase a single premium deferred annuity (SPDA) or a flexible premium deferred annuity (FPDA).
Deferred annuities have two phases: accumulation and payout. In the accumulation phase of a flexible premium deferred annuity, the payments can be made over time. The value of the annuity will increase because there are additional premium payments and there is also potential to earn interest on the money in the annuity over time.
How the funds potentially grow depends on the annuity. A fixed annuity, for example, grows at a fixed interest rate, while a variable annuity allows the funds to be invested in sub-accounts. With an indexed annuity, the rate of growth is tied to the performance of a market index. Keep in mind that investments cannot guarantee growth or sustainment of principal value; they may lose value over time. Past performance is not an indication of future results.
If purchasing an annuity with a lump sum payment isn’t practical for someone, a flexible premium deferred annuity may allow smaller premium payments over a period of time. On the other hand, if one want to use a lump sum to purchase the annuity, a single premium deferred annuity may be a better fit.
What Are the Potential Advantages of Flexible Premium Deferred Annuities?
A flexible premium deferred annuity has several potential advantages. They include:
- Lower initial premium: Generally, a flexible premium deferred annuity can be purchased with less money than a single premium annuity.
- Capital retention: Clients can sometimes hold back some of their money for which they may need to have access. Over time, as those needs change, more funds can be put into the annuity.
- Flexibility: Most of the time the client can pay premiums on their own schedule.
- Potential growth: Clients could set up a flexible premium deferred annuity while they are younger and make relatively low payments in amounts they won’t miss, allowing it to potentially grow over time. As their income increases, they may have the option of making bigger payments.
What Are the Potential Drawbacks of Flexible Premium Deferred Annuities?
There are also some potential drawbacks to flexible premium deferred annuities. For example, the annuity contract may place limits on the amount that can be contributed. Also, if they fail to make premium payments, the annuity could have limited growth. This may make flexible premium deferred annuities a better choice for clients who have a significant amount of time before reaching retirement age.
After purchasing a flexible premium deferred annuity, the client will have to pay surrender charges if the contract is terminated during the surrender charge period. As of current tax laws, there would also be a 10% early withdrawal penalty on top of paying ordinary income tax if under age 59 1/2.
There are different types of annuities and the one that is right for a client will depend on their unique needs.