When it comes to retirement, it’s all about having a well-thought-out plan, understanding your risk tolerance, and accounting for what you’ll need to live comfortably. Whether spending time with your grandchildren, traveling the world, hitting the golf course, spending more time with friends and family, or just staying close to home, understanding your retirement dreams helps you to choose the right investment strategy.

One popular risk-averse retirement solution is annuities. These low-risk investments provide a steady stream of guaranteed income with competitive interest rates. Today’s annuities pay anywhere from 3 to 5 percent interest – and with your principal largely protected – annuities offer retirees an opportunity to supplement their income with guaranteed monthly payments.

Immediate annuities and deferred annuities are the two main types of annuities. So, what are the differences between the two, the pros and cons of each, and which one is best suited for a given situation?

Immediate Annuity

Banks, insurance companies, brokerage firms, and state-chartered and federal credit unions are the main providers of annuities. An immediate annuity – commonly referred to as an income annuity – involves a buyer placing a large lump sum amount into a designated account. In return for that lump sum payment, the annuity pays out a pre-determined principal amount with interest every month.

They are referred to as immediate annuities because monthly payments begin relatively quickly. While most immediate annuities begin monthly payments within a year, some offer initial payouts within a month of making the lump sum payment.

While your lump sum benefits from tax-free, or tax-deferred, compound interest, you still pay taxes upon each monthly payment you receive. However, this can be offset somewhat if your initial lump sum payment into the annuity was already taxed.

Pros of an Immediate Annuity

Retirees choose immediate annuities because of the guaranteed monthly payments they receive. You know exactly how much you’ll be receiving each month, which helps you plan your monthly expenses. It’s also ideally suited to a retiree with a large sum of money but wants that money dispersed to them with interest over their lifetime.

Cons of an Immediate Annuity

While there are pros to an immediate annuity, there are also cons. Among them is the fact that interest rates are lower compared to other investments. There are no payments after death and those payments cannot be transferred to the family members or heirs unless the annuity provides beneficiary protection. Finally, should the financial institution go bankrupt, the entire principal amount could be lost.

Things to Consider

Some immediate annuities may provide a cost-of-living adjustment (COLA). This COLA provision helps protect you against inflation by adjusting your monthly payments to keep up with the rising cost of living. If you experience financial hardship, your immediate annuity may allow you to make a larger emergency withdrawal.

Deferred Annuities

Whereas an immediate annuity is the ideal solution for a retiree who wants to receive monthly payments within a year or less, a deferred annuity is more suited to individuals who want to plan their monthly payments years in advance. With deferred annuities, you have the option of making a large initial lump sum payment or making those payments over time.

Much like an immediate annuity, a deferred annuity largely protects your principal while providing a competitive interest rate. As the owner of a deferred annuity, you choose when your payments begin, and – much like an immediate annuity – your money grows tax-free and is only taxed on withdrawals.

Pros of a Deferred Annuity

In general, a deferred annuity provides a better rate of return and higher monthly payments when compared to immediate annuities. This is because your principal stays within the annuity over a longer period and grows compound interest longer.

Deferred annuities also protect against the rising cost of living (inflation). They allow you to designate beneficiaries in case of death while providing excellent liquidity, as you can often choose whether to receive monthly payments or a single large payout.

Cons of a Deferred Annuity

Unfortunately, deferred annuities have some drawbacks. Withdrawals made before you turn 59½ can include penalties of 10 percent or higher. Management fees and costs are also higher with a deferred annuity compared to immediate annuities and even other investments. This means you need to account for those higher management fees relative to the interest rates you’re receiving.

Again, should the financial institution declare bankruptcy, you could lose your principal amount. Finally, deferred annuities are fairly complex contracts; removing all your money from a deferred annuity comes at the cost of high surrender charges.

Things to Consider

A deferred annuity may be ideal if you’re planning to retire in 10, 20, or 30 years. However, it’s important to be aware of the higher management fees, how much interest you’ll receive, as well as the penalties and surrender charges for early withdrawals. As such, a deferred annuity is best suited to individuals who are committed to investing for the long term and are relatively sure they won’t make early withdrawals.

Invaluable Retirement Insight and Living Advise for Your Golden Years

At WiseSavings, we’re committed to helping our community of 250,000+ satisfied seniors live better, more rewarding lives. From guidance on retirement planning, discounts and rebates on groceries, ideas on how to reduce expenses, and insight into federal assistance programs to help you save more money and become more familiar with today’s technology – our website and newsletter are designed for retirees.

If you have questions about immediate or deferred annuities or want to gain more insight into enjoying your golden years, contact us now.