Deferred Annuities: Single Premium vs. Flexible Premium

How Annuity Premiums Work

A deferred annuity’s premium is the payment a customer makes in exchange for receiving income at a later date. When you purchase an annuity, you can pay the premium in a single payment or multiple installments.

According to the Insurance Information Institute, people often fund their single premium deferred annuities with money from a different qualified account, such as a 401(k) plan or IRA, or from the sale of an appreciated asset.

Flexible premium deferred annuities are funded with a series of smaller payments, which can be set up as automatic transfers or paid directly by the annuity owner at his or her own discretion. This is a helpful option for people who may not have a large sum of money to contribute right away but can afford smaller payments spread out over a longer period of time.

The flexible premium option is available only for annuities with deferred income start dates. Deferred annuities have an accumulation period before the contract annuitizes and the owner begins receiving payments. 

“During the accumulation period, the annuity earns interest or increases in value and, in cases of flexible premium annuities, the annuity owner adds money in the form of additional premium payments,” Brian Kaplan, a Certified Financial Planner^TM professional and Senior Vice President of Lenox Advisors, told Annuity.org.

Immediate annuities, which are also known as income annuities and include single premium immediate annuities (SPIAs) as well as deferred income annuities, don’t have an accumulation phase. However, when you buy a deferred income annuity (DIA), you select the income start date at the time the contract is issued and can make additional premium payments as allowed by your annuity contract.

Pros and Cons of Single Premium Deferred Annuities

SPDAs are ideal for some, but they may pose challenges for others. Do you have a large sum of money that you can contribute now, or might you need access to that money in the short term?

According to Mark Cavalieri, associate director of multi-year guaranteed annuity sales for Senior Market Sales, SPDAs are significantly more popular than their flexible premium counterparts among today’s soon-to-be retirees. Many people approaching retirement have savings to use as a lump-sum premium payment or money from a qualified retirement plan like a 401(k) that they wish to roll over into an annuity.

Pros of Single Premium Deferred Annuities

Principal protection

Your original contribution can be protected from losses, unlike investments made directly in the stock market.

Optimizing compound interest

More funds in the annuity equate to higher potential compounding gains.

Cons of Single Premium Deferred Annuities

Potential surrender charges

The larger the premium payment, the more money you’ll have tied up in the contract. If you encounter a pressing financial obligation that requires you to withdraw funds during the surrender period, you will have to pay surrender charges.

Lack of capital for other investments

This is referred to as “opportunity cost.” Your funds are held in the annuity, so they do not have the opportunity to potentially grow with other products or accounts.

Many SPDAs have a minimum premium, and they provide higher payments with a longer accumulation phase — or a longer period during which the lump sum premium can earn interest.

Pros and Cons of Flexible Premium Deferred Annuities

Flexible premium deferred annuities may suit you if you prefer to divide up your premium payments into smaller amounts. Cavalieri told Annuity.org that most providers require an initial premium of at least $2,000 for a flexible premium annuity, so there is often an established financial responsibility prior to the scheduled payments.

Pros of Flexible Premium Deferred Annuities

Less capital tied up

Smaller payments made over time mean more money at your disposal for immediate needs.

More time to pay

If you do not have the full premium amount, you can make payments over time for the product best suited to you.

Control over premium payment structure

You set the schedule based on your income and comfort level.

Cons of Flexible Premium Deferred Annuities

Less interest accrued and loss of compounding benefits

With less money in the annuity, you miss the compounding interest that accompanies a larger sum premium.

Maximum premium amounts

Like single premium annuities, flexible premium annuities may impose a maximum premium amount.

Cavalieri, who is a life underwriter training council fellow, explained, “Today, the number of single premium annuity products far outnumber the ones with flexible premiums.”

Which Should You Choose: Flexible Premium or Single Premium?

Your time horizon and risk tolerance should influence your decision regarding premium options.

As Cavalieri explained, if someone has a lump sum and a diversified portfolio, single premium annuity products tend to be better options with broader features.

Conversely, flexible premiums can be suitable for conservative savers who may not have a lump sum saved but want a low-risk product with a guarantee of lifetime income.

An annuity owner’s circumstances can change, but it is important to make an informed decision about your annuity product’s terms before signing the contract.

Tax penalties and surrender charges for early withdrawals are considerations common to both single and flexible premiums. It can be costly to change annuity products or contract terms, but you may be permitted to exchange your current contract for a more suitable option under the 1035 annuity exchange rule, as long as you meet certain criteria.

The right premium choice depends on your goals and current financial limitations. Reputable annuity providers and your financial advisor can guide you toward the right solution for you.