What it means
A normal annuity pays out from the first period, such as a pension that starts the month after purchase. A delayed annuity has a gap first.
The buyer pays in either a lump sum or regular contributions during the accumulation period, and the payments to the owner begin only when that period ends. In the insurance world, the delay lets the money grow before payments start.
Because the fund has longer to earn returns, and because the insurer expects to pay for fewer years, the eventual payments can be larger than those from an annuity bought at the same time with immediate payments. The longer the delay, the larger the payments tend to be.
The product is popular for retirement planning. A person in their fifties might buy a delayed annuity that begins paying at 67, creating a guaranteed income for life that complements other savings.
The owner takes on the trade-off that the money is committed, and withdrawals during the delay may be restricted or penalised. In finance, the same idea appears when valuing cash flows that start in the future, such as a lease with a rent-free period or a royalty that begins after a product launch.
The calculation takes two steps: value the payments as of the date they begin, then discount that value back to today. Forgetting the second step is the most common error.
Inflation, interest rates and the financial strength of the insurer are all important. Higher inflation reduces the buying power of fixed payments, and the guarantee depends on the insurer's ability to pay.
It is sensible to compare quotes, check ratings and understand the fees before committing. For valuation work, a spreadsheet with one row per payment and a discount factor for each year makes the logic easy to check.
It also lets you test how the answer changes if the delay is longer or the discount rate is higher. Showing both versions to decision makers avoids false confidence in a single number.
In practice
Real-world examples.
Example
A 50-year-old pays $100,000 into a delayed annuity that will start paying income at age 65. The insurer invests the money in the meantime, and the annual payments are higher than if the income had started immediately. The buyer accepts that no income arrives for fifteen years in return for the higher figure.
Example
A property company signs a lease with a two-year rent-free period, after which rent of $120,000 a year is payable for five years. Its finance team values the lease as a delayed annuity to compare it with an immediate-rent alternative.
Example
A pharmaceutical company agrees to pay a university a royalty of $500,000 a year, starting when a drug reaches the market in three years. The university values the royalty as a delayed annuity and discounts for the risk that the drug may not be approved. It also reduces the value further because the royalty could stop if sales fall short.
Formula
Calculation
Present value = sum of (payment / (1 + discount rate) ^ year of payment)
A business is promised $10,000 at the end of year 3 and $10,000 at the end of year 4, with nothing in years 1 and 2. At a discount rate of 10%, the present value of the first payment is $10,000 / 1.331 = $7,513.15. The present value of the second payment is $10,000 / 1.4641 = $6,830.13. The total present value is $7,513.15 + $6,830.13 = $14,343.28, compared with $20,000 of cash to be received.Case study
Seen in the real world.
Sandpiper Software is an illustrative, fictional company that sold a division and was offered two deals. One paid $900,000 in cash today, and the other paid $200,000 at the end of each of years 3 to 7, which totals $1,000,000 and looks larger on paper.
The finance director valued both deals using a discount rate of 8%. Discounting each delayed payment back to today gave a present value of about $684,600, well below the $900,000 offered in cash, because the two-year delay and the long payment period both reduce value.
Sandpiper is a made-up company and the figures here are for teaching, but the lesson holds. The director chose the cash deal, and she also noted that the delayed payments depended on the buyer staying solvent, which made them riskier still.
Watch out
Common mistakes.
- Adding up the future payments without discounting them for the delay, which overstates their value.
- Discounting the payments only back to the start date of the annuity, and forgetting to discount further back to today.
- Ignoring the charges, restrictions and insurer risk in a retirement annuity.
Questions
People also ask.
Is a delayed annuity the same as a deferred annuity?
Yes, the terms are used interchangeably to describe an annuity whose payments begin after a waiting period.
Why are payments often bigger than from an immediate annuity?
The money has longer to grow, and the insurer expects to pay for fewer years, so each payment can be larger.
What happens if the owner dies during the delay?
It depends on the contract, as some pay a death benefit to a beneficiary while others do not.
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