What is an annuity accumulation period?

When planning for retirement, annuities often enter the conversation as a way to secure a steady income stream. 

Look under the hood of an annuity, though, and you’ll find many moving parts, often with industry-specific terms you might not be familiar with. 

An accumulation period is one of those concepts you should understand if you own a deferred annuity, or if you’re interested in buying one. It’ll help you understand why these financial products sold by insurance companies are non-liquid assets and how the money you invest grows over time. 

Here’s everything you need to know. 

What is an annuity accumulation period?

The accumulation period is the savings phase of an annuity. During this phase at the beginning of your contract, you build up funds through regular contributions, and the money grows tax-deferred via investment returns or compounding interest. 

You typically contribute funds on a regular basis over several years during the accumulation period. Your contributions are invested by the insurance company, and growth depends on the type of annuity you own. It might have a fixed rate, be tied to market investments or track an index.

After the accumulation period, the annuity enters the payout phase, also known as annuitization.

All deferred annuities have accumulation periods. A deferred annuity is simply an annuity that you pay into over a period of time and payouts start at a later date. In contrast, immediate annuities begin payouts 30 days to one year after purchase and have no accumulation phase. 

During the accumulation phase, your earnings grow tax-deferred. But once you enter the payout phase, taxes come due. And a heads-up — if you withdraw funds before age 59 ½, the IRS might hit you with a 10 percent penalty on top of regular income taxes.

How long does the accumulation period last?

Generally, you can adjust the accumulation period to fit your needs, giving you some flexibility when it comes to your payout start date. In some cases, though, annuities may lock in the accumulation period timeline when you purchase the contract. 

For some people, the accumulation phase might last decades as they steadily contribute to their annuity. Others might opt for a shorter timeline. Ultimately, how long this phase lasts comes down to your retirement goals and when you want those income payments to start.

How your annuity value grows during the accumulation period 

The rate at which your annuity grows during the accumulation period directly relates to the type of annuity you own. 

• Fixed annuities: These earn a guaranteed rate of return based on an interest rate set by the insurance company.
• Variable annuities: These allow you to invest in a selection of sub-accounts, which are similar to mutual funds. Returns depend on the performance of the underlying investments.
• Indexed annuities: These tie returns to the performance of a market index, such as the S&P 500, with a cap and a floor to limit gains and losses.

Can you access your money during the accumulation period?

Annuities have a surrender period during the accumulation phase. You generally can’t take any money out in the first year. 

After that, your contract might include a free withdrawal option. This means you can withdraw money each year without the company charging a surrender penalty. Typically, the free withdrawal amount is 10 percent of the accumulated value. 

If you try to withdraw more than the 10 percent yearly limit, surrender charges kick in. 

Generally, surrender charges start at about 10 percent and then drop off each year until the surrender period is over. Surrender periods can last five to 10 years, depending on the contract. 

For example, if you purchase an annuity with a seven-year surrender period and withdraw funds in the third year, you may face a 10 percent penalty on the withdrawal amount. If you take funds out in the fifth year of your contract, you may face a 5 percent surrender charge. 

And don’t forget, you’ll still owe income taxes on at least part of the money you take out, and you might have to pay the IRS’ early withdrawal penalty.

If you withdraw enough money during the early years of the accumulation period, you may end up with less money than you started with.

To avoid penalties, you need to commit to an annuity long-term. If you think you’ll need access to your money during the accumulation period, don’t buy a deferred annuity.

What happens if you die during the accumulation period?

The accumulation period can last years, sometimes decades. It’s unpleasant to think about, but there’s always a chance you could die before receiving a single payment from the insurer. 

So what happens to all the money you’ve put into the annuity — and can you earmark it for your beneficiaries?

Most annuities come with a basic death benefit so your selected beneficiary can receive the money you’ve already paid into the contract. 

Keep in mind though, this generally only applies if you die during the accumulation period. If you’re, let’s say, five years into receiving payments and you pass away, the insurer may keep the remaining principal and your heirs receive nothing unless you pay extra for a death benefit rider.

One alternative is buying an annuity with a period certain. This guarantees that if you die five or 10 years after payments begin, your heirs will at least receive the payouts you would have gotten during that five or 10-year term.

Some variable annuities offer what’s known as an enhanced death benefit, also at an added cost, which locks in investment gains regularly so that your heirs receive more than just the principal you’ve already paid. 

Immediate annuities have no accumulation period

Immediate annuities skip the accumulation period entirely. A single premium payment is made, and income payments typically begin within one month to a year. 

Because the annuity isn’t growing for years on end during the accumulation period, you often need a larger upfront contribution to fund the contract. Otherwise, the immediate annuity won’t have enough funds to provide a meaningful payout. 

Bottom line 

The accumulation period grows your initial investment in an annuity, allowing you to potentially increase its value on a tax-deferred basis. By understanding how it works and carefully considering your options, you can make an informed decision that aligns with your retirement goals.