Longevity is generally considered a blessing. But what if you live so long that you run out of money?
While Americans as a whole are living longer than in past decades, many can no longer count on the steady flow of a pension that provides lifetime income. Instead, individuals are increasingly shouldering the responsibility of crafting their own retirement income streams to supplement their Social Security benefits.
Enter deferred income annuities (DIAs). Sometimes called longevity insurance, DIAs often are purchased as an alternative to a pension by those seeking a set amount of guaranteed income in their later years. These products are typically sold by investment professionals or insurance agents. DIAs should not be confused with deferred fixed income annuities.
Think of DIAs as immediate annuities with a delayed payout phase. In both cases, you hand over a sum of money to an insurance company in exchange for a fixed payout for the rest of your life.
But unlike immediate annuities, the payout from deferred income annuities comes at a predetermined future date. DIA purchasers can also make additional contributions along the way, though insurance companies might impose limitations on additional contributions.
The upside of waiting: Payouts from deferred income annuities are generally larger than what one would get with an immediate annuity, albeit generally for a shorter length of time. One reason for these larger payouts is that some people who purchase these types of annuities will pass away sooner than expected. In the absence of a rider providing otherwise, the excess premiums that individual paid don’t go to the individual’s heirs. Rather, the leftover payments, called “mortality credits,” remain in the “mortality pool” and increase the pot for individuals with longer life spans. At the same time, the deferral period allows insurance companies to invest the premiums at a higher rate of return.
Another avenue for purchasing deferred income annuities is through 401(k) and IRA accounts. An individual is allowed to take a portion of a 401(k) or traditional IRA and use it to buy a Qualified Longevity Annuity Contract (QLAC). The value of the QLAC is excluded from the retirement account balance used to determine required minimum distributions (RMDs) that must be taken when a person reaches age 72.
IRS rules allow investors to use a portion of funds from qualified retirement accounts (up to a limit adjusted by the IRS each year) to purchase a QLAC without it counting as a currently taxable withdrawal. You can delay RMDs for funds used to purchase a QLAC up to age 85, and you won’t start paying taxes on the money until you start receiving payments from your annuity.
Here are some other things to consider if you’re thinking about buying a DIA:
- Once you hand over the money, you can’t get it back. Purchasing a DIA is generally an irrevocable decision. A person is trading liquidity—easy access to their cash—for the promise of a payout in the future. As a result, the decision requires careful consideration. Think about whether you will need this money at some point and what the consequences will be if you don’t have access to it.
- Your heirs could be out of luck. Most DIAs don’t pay your heirs if you pass away before you reach the age when you would have received benefits. You can purchase a rider that allows your heirs to receive a death benefit. But the trade-off is lower payments.
- Don’t forget inflation. Generally speaking, payments from DIAs are not adjusted for inflation, meaning the value of your payout could be eroded over time. You can purchase an inflation protection rider but, once again, this guarantee will reduce your payments.
- The guarantee of future payments is only as good as the insurance company backing them. Though investors in annuities are protected by state guaranty funds if the issuer of the annuity fails, but the guaranty may not cover the full loss. You should look into the guarantee in your state, and investigate the financial stability of the insurance company backing the contract before making this irrevocable purchase. Companies such as Standard & Poor’s provide ratings of insurance companies.
As is the case with any type of annuity, you’re depending on the insurance company’s ability to make good on its promises.