Final answer:
A deferred annuity functions as an accumulation vehicle for retirement savings, with payments starting at a future date. Within a 401(k) or other similar retirement plan, deferred annuities offer potential protection against inflation as opposed to fixed pension plans, aligning with defined contribution plans' growth potential.
Step-by-step explanation:
A deferred annuity is a financial product that serves primarily as an accumulation vehicle for retirement savings, where contributions are made, and investment earnings grow on a tax-deferred basis. The annuity payments commence at a future date, rather than immediately after a premium is paid.
Its main feature is that it allows the annuitant to accumulate capital before the distribution phase begins, which can lead to higher eventual payouts when the annuity enters the payout phase. This accumulation can happen through 401(k) plans or similar retirement savings plans, which offer tax advantages and can invest in a variety of financial products, including annuities.
One significant benefit of deferred annuities within a 401(k) or similar plan is their ability to help protect against the erosion of purchasing power due to inflation, especially when compared to traditional defined benefit pension plans with fixed payments that do not increase over time, leaving retirees vulnerable to inflationary pressures.
In contrast, defined contribution plans like 401(k)s allow for investment in vehicles that can grow and thus potentially offer protection against inflation.