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Are Deferred Income Annuities the Right Choice for your Future?
Low investment yields have robbed many savings vehicles of their appeal. Besides bank CDs and money market funds, fixed annuities also may fail to generate enthusiasm these days. According to Beacon Research, which tracks the annuity industry, fixed annuity sales in the first quarter of 2013 were down 11.7% from the first quarter of 2012. Yet one type of fixed annuity bucked this trend. Beacon reported that sales of deferred income annuities (DIAs) were nearly 150% higher in the first quarter of 2013, versus the first quarter of 2012. Looking back further, New York Life recently announced that DIAs were a $50 million market in 2011; this year, the market is $1 billion and growing rapidly.
Invest now, collect later
DIAs are sometimes called longevity annuities. That is, you can buy one that will pay out as long as you live. If you’re married, you can buy a joint DIA that will pay as long as either you or your spouse is alive. This guaranteed income stream may help prevent you from running short of money if you live well beyond normal life expectancy. Of course, a traditional income annuity (also known as a payout annuity or an immediate annuity) also can provide guaranteed lifetime income. Why are DIAs so popular now? Because they offer much higher yields for consumers who can wait for the cash to start flowing. Typically, DIAs are purchased by pre-retirees who want supplemental retirement income. Example: Ed Larson is single, age 60. He is still working, and plans to retire at age 70. Ed’s current health and his family history indicate he has a good chance of living to age 90 and beyond. By shopping around, Ed learns that he would receive a yield in the 5%–6% range if he were to buy an immediate lifetime annuity now. That is, if he bought this annuity for $100,000, he would receive $5,000– $6,000 a year as long as he is alive. Alternatively, Ed could wait until he retires at age 70 to buy such an annuity. Currently, a 70 year old male could receive $6,000–$7,000 a year from a $100,000 immediate lifetime annuity. Ten years from now, that immediate annuity might have a higher or a lower yield. Instead, Ed buys a $100,000, 10- year DIA. Currently, such an annuity could yield around 10%. Thus, Ed pays $100,000 now and doesn’t start collecting until 2023. Starting then, Ed can receive $10,000 a year throughout his retirement, no matter how long that might last. (Joint annuities have lower payouts than single life annuities.)
Nothing for something
For today’s pre-retirees, the idea of a 10% investment return, guaranteed, with no ending date, may be attractive. You’ll be confident that money will keep coming, regardless of what happens in the stock or bond markets. Nevertheless, DIAs come with risks you shouldn’t ignore. Keep in mind that DIAs might be guaranteed, but that guarantee doesn’t come from any government agency. DIAs are backed by the assets of the issuing company, so you should check into the insurer’s financial health before buying a DIA. Your own physical health also is a major concern. If Ed Larson in our example buys an age 70 DIA when he’s 60 and dies at, say, age 68, no one will collect a penny from his $100,000 investment. Also, Ed won’t have access to his $100,000 if he needs money before age 70. (Some DIAs have refund options, but you’ll have to accept a lower payout if you want this opportunity.) Therefore, you should consider your longevity prospects before deciding to put part of your retirement fund into a DIA.