Immediate vs. Deferred Annuities: When and How Payouts Start

One of the first questions about any annuity is simple: when does the money start coming back to you? The answer splits annuities into two families, immediate and deferred, and it shapes almost everything else about how the contract works.

The SEC's Investor.gov and the NAIC both use this split. An immediate annuity starts paying soon after you buy it. A deferred annuity gives your money time to grow first and pays out later. Within each family, you also choose how payments are made and how long they last.

This guide explains both families and the main payout choices. It is general information, not financial, insurance or tax advice.

Immediate annuities: income starts soon

With an immediate annuity, Investor.gov explains, you make a single payment and typically start receiving income within one year of purchase. FINRA's 2022 guide to immediate annuities says income from a fixed immediate annuity often begins within 30 days and always within 13 months. There is no accumulation phase; the contract goes straight to paying you.

FINRA describes the payments as monthly, quarterly, semiannual or annual, and generally guaranteed to last as long as you live or, depending on the contract, for a set period such as 10 or 20 years.

Immediate annuities come in two main forms:

• A fixed immediate annuity pays the same amount each period regardless of market conditions, for the period stated in the contract.
• A variable immediate annuity lets you allocate your money among underlying investments, so your payments rise and fall with how those investments perform.

FINRA is candid about the trade-offs. Fixed immediate payments typically trail what stock and bond portfolios might earn in a strong market, and a fixed payment buys less over time as prices rise. Riders that add cost-of-living or fixed increases are sometimes available, but they raise the cost.

Deferred annuities: grow now, pay later

With a deferred annuity, Investor.gov says, you pay in with a single payment or flexible payments over time, and your money grows tax-deferred before income starts. That growth period is the accumulation phase; the period when payments begin is the payout phase.

Deferred annuities come in all the main types, from fixed to variable, which our guide in this section on fixed, indexed and variable annuities compares. Because money stays in the contract for years, deferred annuities are where surrender charges matter most. Withdrawals during the surrender period can cost you, and Investor.gov notes that some contracts also apply market value or interim value adjustments that are often negative.

Deferred income annuities: a pension-like promise for later

A deferred income annuity sits between the two families. FINRA describes it as an immediate annuity with a delayed payout: you hand over money now in exchange for a fixed payout for life that starts at a predetermined future date. FINRA notes these are sometimes called longevity insurance and should not be confused with deferred fixed annuities.

According to FINRA, payouts are generally larger than an immediate annuity's, though usually for a shorter period. One reason is that some buyers die before or soon after payments start, and without a rider their leftover premiums stay in the insurer's "mortality pool," which increases what longer-lived buyers receive.

FINRA also lists the drawbacks. The purchase is generally irrevocable, most contracts pay heirs nothing if you die before payments begin unless you add a death benefit rider, and payments are generally not adjusted for inflation. FINRA also notes that a special version, called a qualified longevity annuity contract, can be bought inside a 401(k) or traditional IRA up to a limit the IRS adjusts each year; check the current IRS rules before relying on it.

How you take money out of a deferred annuity

When a deferred annuity reaches the point where you want income, FINRA describes three broad paths:

1. Annuitize. You convert the contract into guaranteed income for a set period or for life. The decision is generally irrevocable. You give up control of the money, and the risk of outliving it shifts from you to the insurer.
2. Take systematic withdrawals. You withdraw money on a schedule while keeping control of the account, but you give up the insurer's guarantee that you won't outlive your money.
3. Take a lump sum. You withdraw the value, which can trigger surrender charges if you are still in the surrender period, plus taxes.

FINRA also notes that some insurers offer riders that guarantee lifetime withdrawals without annuitizing, at an added cost. Investor.gov adds that some variable annuity contracts annuitize automatically at an advanced age, such as 95, so check your contract's terms.

Choosing how long payments last

Whether you buy an immediate annuity or annuitize a deferred one, you choose how long payments run. The common options described by FINRA and Investor.gov include:

• For your lifetime.
• For the lifetime of you and your spouse or partner.
• For a specified period, such as 20 or 25 years.
• For life with a period certain, which FINRA describes as a guarantee that payments continue to a beneficiary for a set time if you die early.

Each choice changes the size of the payment. FINRA explains that adding a period certain or any death benefit costs more, meaning you need a larger lump sum for the same income. Put the other way, a lifetime-only payment without those extras buys more income for the same lump sum, but it carries the risk FINRA spells out for immediate annuities: if you die unexpectedly early, you will have received relatively little, and unless the contract includes a death benefit, your heirs receive nothing.

FINRA also cautions that whether payments continue after your death depends on the type of annuity and its specific provisions, so ask the seller to show you that language in writing.

Questions that point you to the right family

For example, imagine a hypothetical 68-year-old who has just retired and wants a fixed paycheck to cover basic bills starting next month. That need points toward the immediate side. Compare that with a 55-year-old who wants money to grow for 10 years before deciding how to use it, which points toward the deferred side. Before choosing either, ask yourself:

• When do I actually need income to start?
• Could I need this money for an emergency before then? Investor.gov notes that annuities generally don't allow withdrawals once income payments have started.
• Do I want payments to continue for a spouse or heirs, and am I willing to accept smaller payments for that?
• How will rising prices affect a fixed payment over 20 or 30 years?
• How strong is the insurer? FINRA reminds buyers that the annuity is guaranteed only as long as the issuing insurer remains in business.

For personal guidance, contact your state insurance department or a licensed financial or tax professional. Be wary of anyone who pressures you to decide on the spot; the NAIC's consumer checklist starts with "Read the fine print."

Key takeaways

• Immediate annuities start income soon after purchase; deferred annuities let money grow first.
• Deferred income annuities promise larger later payments in exchange for giving up access to your money, usually irrevocably.
• From a deferred annuity, you can annuitize, take systematic withdrawals or take a lump sum, each with different trade-offs.
• Payout options range from lifetime-only to joint life to a set period; protecting heirs reduces each payment.
• Fixed payments usually lose purchasing power to inflation unless you pay extra for an increase rider.

Sources - U.S. Securities and Exchange Commission (Investor.gov), Annuities — https://www.investor.gov/introduction-investing/investing-basics/investment-products/annuities - U.S. Securities and Exchange Commission (Investor.gov), Variable Annuities — https://www.investor.gov/introduction-investing/investing-basics/investment-products/annuities/variable-annuities - FINRA, Annuities — https://www.finra.org/investors/investing/investment-products/annuities - FINRA, Immediate Annuities: Money Now and for the Rest of Your Life ... for a Price — https://www.finra.org/investors/insights/immediate-annuities-money-now-and-rest-your-life - FINRA, Deferred Income Annuities: Plan Now for Payout Later — https://www.finra.org/investors/insights/deferred-income-annuities - National Association of Insurance Commissioners, What You Should Know Before Buying an Annuity — https://content.naic.org/sites/default/files/consumer-what-to-know-before-buying-annuity.pdf