The basic definition of an annuity is a stream of payments. However, the annuity products sold by insurance companies come in different forms that define when those payments are paid for and when they start and stop. A single premium deferred annuity can be used to set aside a lump sum of money to be used later in retirement.
A single premium deferred annuity is an annuity that is funded by a single contribution rather than periodic contributions.
What is a Deferred Annuity?
An annuity is a stream of income paid for with an initial amount of money. With a deferred annuity, the stream of income – the annuity – does not have a set start date. Instead, the money used to buy the annuity earns interest and the annuity contract increases in value until the annuity owner decides it is time to convert the contract to retirement income or withdraw the accumulated value. A deferred annuity is more of a savings account during the deferral phase.
What is a Single Premium Deferred Annuity?
A single premium annuity is purchased with a single lump sum payment. You cannot add more money later to a single premium deferred annuity you have purchased. As a result, single premium annuities are used to put larger amounts of money to work earning interest. The typical single premium deferred annuity will have a minimum investment amount of $5,000 or $10,000 and a maximum of $1 million or more.
Benefits of a Deferred Annuity
The primary benefit of a deferred annuity is that interest earned on the annuity grows tax-deferred, so deferred has a double meaning with this type of contract. Annuities also have guaranteed principal values and pay competitive rates of interest. This type of contract is used to invest a larger amount of money and not pay taxes on the earnings until the money is needed in retirement. When the owner decides to take money from a deferred annuity, there is a range of choices including a selection of annuity payment options including receiving an income for life.
Penalties and Fees Associated with Deferred Annuities
The tax-deferred feature of single premium deferred annuity interest comes coupled with a tax penalty if money is withdrawn from the annuity before age 59 1/2, thus the focus on retirement savings with annuities. An annuity will also have surrender fee charges if a contract is cashed out within the first several years after purchase. Deferred annuities can vary significantly from insurance company to insurance company, so it is important to understand the different features of a contract before purchase and some comparison shopping may produce a more attractive choice.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.