The concept of a flexible premium deferred annuity is used by many as an alternative to bank saving accounts or other forms of investments. This type of investment option provides an individual with the flexibility of deciding the amount and time of contribution to the annuity.
One of the best ways of understanding any financial instrument such as annuity is to decode the name of the annuity and its characteristics. This will help us to define this type of annuity.
- A premium is the installment payment that you need to make to the annuity company, on a periodic basis. A flexible premium indicates that the premium is not regulated or fixed and it can be paid by the borrower as per his or her convenience.
- The word deferred annuity on the other hand, indicates that there is a time period between the investment and returns phases.
There is therefore a fine defining difference between common annuities and the deferred annuity. A flexible premium deferred annuity, in short, offers more flexibility but the repayment schedule is deferred or rather delayed. It must be noted that a flexible premium annuity can be fixed annuity as well as a variable annuity.
Definition
The concept of annuity is a combination of mutual funds and insurance contracts. An annuity contract or provision where the annuitant or the contract holder pays the annuity company a set of installments, which are of course, known as premiums. These funds are then invested by the annuity company into very reliable channels, under the supervision and direction of fund managers. A certain volume of returns are obtained by the company from these investments. These returns are shared by the company with the annuity contract holders. Now in case of normal annuity contracts, the payment and repayment (returns) schedule tend to overlap each other. In such cases, the returns start coming in after a few years of premium payments, upon which they continue till the end of the schedule.
In case of any kind of deferred annuity, a small gap of time, conventionally a year or a few months is taken after the end of the premium schedule. After this gap, a systemic payment schedule with payments, spanning regular intervals are made. Apart from the repayment feature, an annuity also tends to have a certain death benefit. In case of a flexible premium, this death benefit tends to depend upon what is known as a cash balance of the entire account.
Working
Apart from this differentiation in the mechanism of the premium payment and the reruns schedule, there are some more characteristics of flexible premium annuity that we need to understand.
- Being a flexible premium annuity, there is no fixed or mandated amount that is to be paid by the annuitant, or the contract holder. In some cases, the company may however, prescribe a certain minimum amount that needs to be paid on an annual basis to keep the annuity valid.
- The calculation and computation of the returns of the flexible premium deferred annuity, is also a bit different from normal annuities. The returns are calculated on the basis of cash balance.
- The return per one repayment is usually computed as: No of years the premium was used to accrue returns (*) {total amount of premium in one installment (*) prescribed rate of return}.
Thus your returns depend upon how much you invest per month or per premium installment. Rule of thumb is, invest the maximum in the initial premium installments. This will get you better returns in the first few returns. This is due to the fact that the first few premium installments have a greater time to accrue returns on them.
In some cases, where a flat and fixed percentage rate of return is applied on your investment, this rule of thumb does not apply. In the mechanism of flexible premium deferred annuities there are some annuities which have a variable rate of return, which is based upon the performance of the portfolio of the annuity.
