Deferred Income Annuities Offer Pension-Like Retirement Benefits
Many retirees no longer have the benefits of a traditional pension plan and its guaranteed lifetime income. Even so, people continue looking for methods to create a pension-like benefit. Those who have accumulated a sum of money over time may have looked to an immediate annuity to provide the income stream they desire. Now the insurance industry has created an alternative solution: a deferred income annuity (DIA).
Sometimes referred to as a longevity annuity, a DIA works much like conventional annuity products except the payments do not start right away. The holder provides a lump-sum payment to the insurance company in exchange for guaranteed lifetime income that begins at a future date, sometimes up to 30 or more years down the road.
Although DIAs are sold by insurance companies, they should not be confused with a cash value life insurance policy, which can also offer benefits in retirement planning, including tax savings for high income earners.
How a deferred income annuity works
When a person purchases a deferred income annuity contract, the payout date is determined and the insurance company guarantees a set amount. It is important to note that DIAs are not liquid investments. When you invest in one, you completely forfeit the initial premium. Several products have some liquidity options, but they can be difficult to invoke and are often subject to surrender fees.
Deferred income annuities offer significantly higher payouts than their immediate annuity counterparts. Consider this example of a hypothetical 60-year-old man comparing the differences between an investment in a deferred income annuity versus an immediate annuity.
Potential advantages of deferred income annuities
Nash is 60 years old and nearing retirement. He expects to follow in his parents’ footsteps and live into his 90s. Nash decides to invest $100,000 in a DIA, and he wants the payments to start at age 80. At the time of this writing, after the 20-year deferral period, Nash will be able to withdraw around $42,000 per year for the rest of his life. So, if he lives to age 95, he will have received $630,000 in income from his initial $100,000 investment.
Now, what if Nash decides to wait until he is 80 years old and he invests in an immediate annuity? Let’s assume that the $100,000 he had at age 60 was put into conservative investments yielding 3 percent interest per year for that 20 years. By age 80, he would have about $180,000. An 80-year-old investing $180,000 in an immediate annuity will receive about $1,500 per month, or about $18,000 per year. So, if Nash lives to age 95, he will receive about $270,000 in income.
In this scenario, the advantages of a deferred income annuity are clear. Of course, this example is hypothetical and actual payout amounts will vary based on age, deferral period, and interest rates at the time of purchase.
A caveat about your principal
With most deferred income annuity-based products, the holder forfeits the principal in exchange for the guarantee of future payments. In order to pass the investment on to heirs in the event of the holder’s death, some insurance companies offer optional riders. Another option adjusts for annual inflation and provides larger payments.
Deferred income annuities are just one of many options to consider when planning retirement income. The best way to formulate a personalized solution is to talk to a qualified financial advisor.