Deferred Income Annuities
We’ve talked a lot aging, retirement, longevity, and, of course, annuities. But let’s narrow our focus further and discuss deferred income annuities (also know as a DIA).
Deferred income annuities are a useful tool for protecting your retirement savings , against longevity risk. Longevity risk is the risk that you live a lot longer than you expect, therefore outliving your money. So how do DIAs work? Let’s break it down. The deferred part means that after you pay the premium to purchase your annuity there will be a period ranging from a year to several years before you begin receiving income. The income part refers to the promise of an annuity to provide you with a fixed paycheck, received monthly or yearly. Finally, the annuity aspect refers to the insurance company’s promise to continue sending payments for as long as you live.
The deferral period, the time between purchase and payments, must be at least 1-2 years, but is often much longer. A 55 year old who purchases a DIA might defer payments until age 80-85. Why the wait? The longer you defer payments, the longer the insurance company has to invest your money, and the more it will grow, and the more the insurance company is willing to promise you. Additionally, the longer you stave off receiving payments, the more confident the insurance company is that they won’t have to pay you for too long, so the better price you’ll get.
Though the concept behind a deferred income annuity isn’t new, its sales have just begun to takeoff. In 2011, there was only one annuity provider selling a premium volume of about $50 million. By 2014, the premium volume rose to $2.7 billion and the number of providers jumped to 13. Through the Abaris platform, you have access to a number of insurers: MassMutual, AIG, Principal Financial Group, Lincoln Financial Group, Guardian, Symetra, Americo, and Pacific Life. The products offered by these insurers vary, in terms of price, flexibility of premium payment, ability to commute value, and many more aspects. Whatever the differences, though, reputable authorities, including The Wall Street Journal, The New York Times, CNN Money, and Barron’s, have all sung the praises of a DIA, sighting its simplicity, security, and better pricing for you, in terms of premium and payments.
DIAs are a powerful tool, but they’re not necessarily right for everyone. What makes for a good fit? If you’re age 45-65, pre-retirement or in early retirement, in at least average health, don’t need to access the money from the annuity income immediately, have no pension, have basic expenses greater than your Social Security can cover, and want a simpler annuity then chances are you’re a good fit. In addition to these attributes, a good candidate for a DIA can say with surety that they won’t need access to the money spent on the premium, as the product has no cash or redemption value.
Once you know if you’re a good fit for a deferred income annuity, there are a few important things to note during your product search. The first is inflation. While the dollar amount of your payout is fixed, meaning it’s guaranteed not to change, the purchasing power of that dollar amount is dependent on inflation. If you purchase your annuity with inflation protection, then the payout over time will go up. The specific rate of increase will depend on the inflation rider you selected. On the other hand, if you purchase an annuity without inflation protection, the purchasing power of your payout declines. Another thing to consider when purchasing your annuity is the credit rating of the insurer you choose. It’s advised that you shouldn’t purchase from a provider with a credit rating below an A. At Abaris, we only carry insurers with credit ratings in the top quartile, based on the Comdex Index, so you can rest assured, knowing you’re working with a highly-rated provider.
Besides inflation and credit risk caveats, you should know about a few features you can add to the simplest DIA. The first feature pertains to protecting yourself against the ramifications from the unfortunate possibility that you pass away sooner than expected. This feature comes in a number of varieties: a cash refund, death benefit, return of premium, or period certain. Each of these is slightly different, but they all serve the same general function. The upside of these items is that, in the event of a premature death, the beneficiaries still get something. The downside, however, is that it makes your annuity more expensive, while straying from the fundamental goal of a DIA. Rather than protecting just against living a long life, as a plain DIA does,adding a cash refund or other similar riders means that you’re now attempting to also protect against the risk of living a short life. Due to these opposing aims, we do not recommend purchasing this type of feature with your annuity, unless you absolutely can’t live without it.
The second feature you can purchase with your annuity is called an inflation rider. As the name implies, it protects against inflation, or the risk that your fixed payments won’t maintain the same purchasing power in the future. An inflation rider aims to provide consistent purchasing power, by ensuring that your annuity income increases with increasing inflation. The upsides of an inflation rider are great. First of all, it makes inflation the insurer’s problem, not yours, which removes the stress of predicting future inflation. It also better aligns your income with your expenses in retirement. The drawbacks? With added protection comes added cost, of course, manifesting in either a higher premium or lower overall payout. The added cost comes without the guarantee that inflation will rise enough that the added protection is worth the cost. The rider also fails to cover you during the deferral period. Drawbacks aside, we think an inflation rider is a valuable feature for the majority of people to add to their annuity purchase.
Purchasing a deferred income annuity is an important decision with a lot of moving pieces. The most important first step is to be informed. Use our advice tool to figure out if you’re fit or our quoting tool to compare quotes with just a few clicks of the mouse. And, as always, don’t hesitate to reach out with any questions.