When You Get Paid: Deferred vs. Immediate Annuities

The core difference: when the payouts begin

An when ready annuity starts sending you payments within a year of purchase, usually within a few months. A deferred annuity sits untouched for years or decades, then begins paying you later — at a date you choose or when you reach a certain age.

The choice between them hinges on when you need the money and how long you want your savings to grow before withdrawals start. Someone retiring at 65 and needing income right away would look at when ready annuities. Someone at 55 who won't need the money until 70 might use a deferred annuity to let contributions compound longer.

Both are contracts with an insurance company. You give them a lump sum (or sometimes a series of payments), and they promise to pay you back over time. The timing of those paybacks is what sets them apart.

Key Takeaways

• when ready annuities begin paying you within months of purchase; deferred annuities wait years or decades before payments start.
• Deferred annuities let your money grow tax-deferred during the waiting period, potentially increasing the size of future payments.
• when ready annuities lock in a payment amount based on current interest rates and your age at purchase; deferred annuities' payment amounts depend on rates and your age when payouts begin.
• Deferred annuities often include a surrender period — typically 5 to 10 years — during which withdrawals beyond a small annual amount trigger penalties.
• Both types convert a lump sum into a stream of income, but the timing and growth phase differ significantly.

How money grows during the waiting period

With an when ready annuity, there is no waiting period. The insurance company takes your money and starts paying you almost at once. The growth phase is essentially over before you sign the contract.

With a deferred annuity, your money sits in the insurance company's account and grows tax-deferred. You do not pay income tax on the earnings each year the way you would in a regular investment account. That tax deferral means more of your money stays invested and compounds. If you contribute $100,000 to a deferred annuity at age 55 and do not touch it until age 70, the balance will be larger than if you had paid taxes on the gains along the way.

The trade-off is that you cannot access that money easily during the growth phase. Most deferred annuities have a surrender period — usually 5 to 10 years, sometimes longer — during which you can withdraw a small percentage (often 10 percent per year) without penalty. Anything beyond that triggers a surrender charge, a fee the insurance company deducts from your withdrawal.

Payment amounts and how they are set

The amount you receive each month depends on three things: how much money you put in, your age when payments start, and interest rates at that moment.

With an when ready annuity, all three factors are locked in when you buy it. You hand over $200,000 at age 67, and the insurance company calculates your monthly payment based on current rates and your life expectancy. That payment stays the same for life (in a fixed when ready annuity) or adjusts for inflation (in a variable or inflation-adjusted version). You know the exact number before you sign.

With a deferred annuity, the payment amount is not set until the payout phase begins. You might contribute $200,000 at age 55, but the actual monthly payment you receive starting at age 70 depends on interest rates 15 years from now. If rates are higher in 15 years, your payment will be higher. If rates are lower, your payment will be lower. This uncertainty is the cost of waiting — you gain growth potential but lose the certainty of knowing your exact payment in advance.

Surrender periods and withdrawal restrictions

when ready annuities typically have no surrender period because there is nothing to surrender — you are already receiving payments. Once the contract is active, you get your money according to the schedule you chose.

Deferred annuities almost always include a surrender period. During this time — commonly 5, 7, or 10 years from purchase — you can withdraw a small amount each year (the "free withdrawal" amount, often 10 percent) without penalty. Anything more triggers a surrender charge, which is a percentage of the amount withdrawn. A 7 percent surrender charge on a $50,000 withdrawal costs you $3,500.

The surrender period exists because the insurance company is betting on keeping your money invested for a set time. If you pull it out early, they lose the growth they expected. Once the surrender period ends, you can usually withdraw money without penalty, though you will still owe income tax on any earnings.

Tax treatment during and after the payout phase

Both when ready and deferred annuities are tax-deferred during the accumulation phase (the waiting period for deferred annuities, or before purchase for when ready annuities). But once payments begin, the tax picture differs slightly.

With an when ready annuity, each payment you receive is partly a return of your original contribution (not taxed) and partly earnings (taxed as ordinary income). The insurance company calculates the split using an exclusion ratio based on your life expectancy. If you contributed $200,000 and the annuity will pay you $300,000 total over your lifetime, two-thirds of each payment is a return of principal and one-third is taxable earnings.

With a deferred annuity, the same exclusion ratio applies once payouts begin. But because your money has grown during the deferral period, the earnings portion is usually larger. If your $200,000 grew to $350,000 by age 70, more of each payment will be taxable than if you had bought an when ready annuity at 70 with $350,000.

If you withdraw money from a deferred annuity before the payout phase begins, the withdrawal is taxed on a last-in-first-out basis — earnings come out first and are taxed as ordinary income. If you are under 59½, you may also owe a 10 percent early withdrawal penalty on the earnings portion.

Who typically chooses each type

when ready annuities suit people who are already retired or about to be, have a lump sum they want to convert to steady income, and do not need flexibility. Someone who receives a $500,000 pension payout at 65 and wants may provide monthly income for life might buy an when ready annuity with part or all of it.

Deferred annuities suit people who are still working, have years before retirement, and want tax-deferred growth without the restrictions of a 401(k) or IRA contribution limit. Someone at 50 with $100,000 to invest who will not retire until 70 might use a deferred annuity to let that money grow untouched for two decades.

Deferred annuities are also used as a tool to bridge the gap between retirement and Social Security. Someone retiring at 62 might buy a deferred annuity that begins paying at 70, so they have may provide income waiting when they turn 70 and claim Social Security.

Comparing costs and fees

when ready annuities are generally simpler and have fewer moving parts, so they often carry lower fees. You pay the insurance company's margin — the difference between what they earn on your money and what they pay you — but there are usually no annual management fees or surrender charges.

Deferred annuities often carry multiple layers of costs: surrender charges during the surrender period, annual management fees (if it is a variable deferred annuity with investment options), and sometimes rider fees for optional features like may provide minimum income or death benefits. These fees reduce the amount available to grow and the amount you eventually receive.

Always ask the insurance company or agent for a written breakdown of all fees before you buy. The cost of a deferred annuity can vary widely depending on the features included.

Frequently Asked Questions

Can I change my mind after buying a deferred annuity?

During the surrender period, you can withdraw money, but you will pay a surrender charge on anything above the free withdrawal amount. After the surrender period ends, you can usually withdraw without penalty, though you still owe income tax on earnings. Some deferred annuities allow you to exchange it for a different annuity without triggering surrender charges, but this depends on the contract.

What happens to my money if the insurance company fails?

Each state has a guaranty fund that protects annuity holders if an insurance company becomes insolvent. The protection limit varies by state but is typically $100,000 to $250,000 per person per company. This is separate from FDIC insurance and applies to both when ready and deferred annuities.

Can I buy an when ready annuity and a deferred annuity at the same time?

Yes. Some people use a strategy called a "ladder" where they buy an when ready annuity for current income and a deferred annuity that will start paying later. This gives them may provide income now and a larger payment later, spreading out the timing of their annuity income.

Do I have to take all the money out of a deferred annuity when the payout phase begins?

No. You can choose how the deferred annuity pays out — as a lump sum, as monthly payments for life, as payments for a set number of years, or as a combination. The contract will specify your options when you purchase it.

What is the difference between a fixed and variable deferred annuity?

A fixed deferred annuity earns a set interest rate during the growth phase, so you know the minimum value when payouts begin. A variable deferred annuity lets you invest in subaccounts (similar to mutual funds), so growth depends on market performance. Variable annuities typically have higher fees but more growth potential.