What Is a Deferred Annuity?

As people live longer, retirement savings need to last more years. A deferred annuity can help by letting you invest now and receiving income later. This usually begins in retirement when other income declines, allowing your money to grow tax-deferred and potentially provide larger payments over time. According to LIMRA’s U.S. Individual Annuity Sales Survey (which represents 92% of the total U.S. annuity market), annuity sales are expected to surpass $400 billion in 2025¹. If you have several years until retirement, this type of annuity could add stability to your plan. A financial advisor can help you review the benefits, costs and how it fits into your overall strategy.

Deferred Annuity Defined

A deferred annuity is a long-term investment in which you invest a sum of money, then receive payments several years down the line after the initial sum has accrued interest.

Unlike its counterpart, the immediate annuity, the deferred annuity has two distinct components: an investment phase and an income phase. The investment phase begins when you purchase the annuity, and it ends when you make your last contribution. You have the option to contribute to the annuity in one lump-sum payment or in several contributions over a longer period of time.

The income phase begins when you receive your first payment from your annuity. Just like the investment phase, you have a few options for how you would like to receive payments. You can receive everything at once in a lump-sum payment, or you can receive a set amount periodically until the annuity runs out of funds. You can also annuitize the account to receive regular payments for a set number of years or guaranteed payments for the rest of your life.

A key feature of deferred annuities involves the manner in which they are taxed. When purchased within a retirement account the annuity is considered qualified and you are able to contribute to your deferred annuity with pre-tax dollars. The funds will then be taxed as ordinary income once you withdraw them. To avoid a 10% penalty fee from the IRS, you’ll need to wait until age 59 1/2 before withdrawing anything. Annuities purchased outside of retirement accounts are considered nonqualified. Because these are purchased with after-tax money only the portion of a withdrawal attributable to gain is taxed.

Types of Deferred Annuities

When you purchase a deferred annuity, you will have to choose from among a fixed, variable or indexed annuity. Each option has unique pros and cons, so make sure to do your homework and choose the option that aligns most closely with your risk tolerance.

A fixed annuity is the most stable option, but it could also have a lower return. The interest rate is determined when you purchase the annuity, and it never changes.

With a variable annuity, you and your insurer will choose a dozen or more stocks, bonds or other money market funds and use their performance to determine the interest rate for the annuity. Variable annuities have the potential for high returns, but there is also risk of poor performance.

An indexed annuity is the most complex of the options. Like the fixed option, you have a minimum interest rate guarantee. How high the interest rate rises is determined by the performance of a market index like the S&P 500. Indexed annuities often have several stipulations that may limit your return.

Despite that complexity and risk, sales of registered index-linked annuities surged in the first quarter of 2025 more than 11% over the year-earlier level.

Deferred Annuity vs. Immediate Annuity

The difference between deferred annuities and immediate annuities is fairly self-explanatory. Immediate annuities begin paying out returns immediately. Deferred annuities sit undisturbed for years before you make any withdrawals, which makes them more attractive as part of a retirement plan.

Many deferred annuity contracts will have a process in place to convert into an immediate annuity should you need your money earlier than you expected. However, this option still may take several years to become available. It could also come with additional fees. If you are purchasing a deferred annuity, you should be prepared to wait several years before seeing any returns.

Payout Options for Deferred Annuities

Once the income phase of a deferred annuity begins, you can choose how to receive your money. The right payout option depends on whether you want steady income for life, predictable payments for a fixed period, or flexibility to access all the funds at once. These choices affect both your retirement income stream and what, if anything, is left for your beneficiaries.

The most common structure is lifetime income, which guarantees payments for as long as you live. A joint and survivor payout extends that guarantee to a spouse, though monthly payments are typically smaller. A fixed-period payout offers payments for a set number of years, while a lump-sum payout gives you all of the funds at once—often leading to higher taxes. Some contracts also include a cash refund option, which ensures any unpaid principal is returned to your beneficiary if you pass away early.

Common Payout Options

Who Should Consider a Deferred Annuity?

A deferred annuity can be a good fit for investors who have already saved in traditional retirement accounts and want additional tax-deferred growth. High earners who are ineligible for Roth IRA contributions may also use deferred annuities as an alternative tax strategy.

They are most useful for people in their 40s or 50s who want to build guaranteed income for retirement, or for those nearing retirement who don’t need immediate payouts but want income later in life. Deferred annuities also appeal to individuals worried about outliving their assets since they can be structured to pay income for life.

On the other hand, deferred annuities are less liquid than other investments and may not be appropriate if you need easy access to cash. They work best for investors with moderate to high tolerance for fees and long holding periods.

Here’s a checklist with common questions to ask before buying a deferred annuity:

• Is the insurer financially strong and covered by my state’s guaranty association?
• Have I already maxed out contributions to my 401(k) and IRA?
• Can I commit to keeping this money invested for seven to 10 years or more?
• Do I understand the contract fees, surrender charges, and restrictions?
• Will the guaranteed income line up with my retirement budget and timeline?

When Should You Purchase a Deferred Annuity?

The best time to buy a deferred annuity is when you still have several years until retirement and want to lock in future income. Buying earlier allows more time for your money to grow during the accumulation phase, but you should be prepared to keep the funds invested for at least seven to ten years. Withdrawals during the surrender period usually face penalties of 7% to 15%, which decline over time.

Deferred annuities also have no IRS contribution limits, making them an option once you’ve already maxed out accounts like 401(k)s and IRAs. However, any withdrawals before age 59½ are subject to a 10% IRS penalty plus ordinary income taxes. Once payouts begin, the income is also taxed at ordinary income rates, which may be higher than capital gains taxes.

Because of the fees, commissions, and surrender charges, deferred annuities are best suited for long-term retirement income rather than short-term savings needs. The decision on timing should balance how long you can leave the funds untouched with when you expect to need reliable income in retirement.

Bottom Line

If you’re still years from retirement and want to boost future income, a deferred annuity may be a good option, but it’s important to understand the fees, surrender periods and contract conditions that can reduce returns. Before committing, review the annuity’s terms carefully, including how long funds are locked in and what death benefits apply.

Retirement Planning Tips

• In any retirement conversation, it’s always important to be mindful of the retirement tax laws in your state. Taking your state’s laws into account can make a significant difference as you plan for retirement.
• If you need help managing your taxes in retirement, a financial advisor can work with you to create a plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• Before you can save enough for retirement, you have to know how much you need in the first place. SmartAsset’s retirement calculator can help you determine how much you need to live the life you want in retirement.

Photo Credit: ©iStock.com/shapecharge, ©iStock.com/simonkr,  ©iStock.com/PeopleImages