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Which Annuity Product is More Efficient? A SPIA or a DIA?

Morningstar recently published a video on their website comparing the pros and cons of single premium immediate annuities and deferred income annuities.  Neither annuity product is “better” than the other, but each has their benefits and drawbacks for an individual retirement plan.  Christine Benz interviewed Morningstar’s head of retirement research, David Blanchett, for the article “Pros and Cons of 2 Key Annuity Types.”  Mr. Benz recently conducted research on both annuity types to determine which product would be best for different individual scenarios.  He first explained the basics of both annuities.

Single premium immediate annuities, or SPIAs, guarantee you lifetime income after you pay a lump sum to an insurance company.  These products have been around for centuries and centuries, so they have stood the test of time.  You are essentially purchasing an income stream with the sum of money that you have today.  With deferred income annuities, also known as longevity annuities or insurance, you still pay a lump sum of money to an insurance company up front.  But with a DIA you don’t receive income payments until later in life.  One common way that people purchase deferred income annuities is that they buy one at age 65 and defer the income for 20 years until they turn 85.

A large marketplace is one of the main benefits of purchasing immediate annuities.  There are so many companies selling them that you have almost unlimited options.  You also are trading your wealth for income immediately, rather than having to wait to see where your money is.  This benefit is also a cost for SPIAs because you are getting your income immediately, rather than taking on the risk that you will die before receiving income payments.  The delay in income payments makes a deferred income annuity cheaper, in essence, than a single premium immediate annuity.  It costs less to purchase a larger income stream when you won’t be receiving it until later in life.  This is because you might not reach the age that you deferred income until or you might not receive payments as long.

The current lower interest rate environment is definitely a concern when it comes to any fixed annuity product.  Annuity income payments are based off of current interest rates and your life expectancy.  While it certainly shouldn’t deter you from purchasing an annuity product, interest rates are something to consider.

Since Mr. Blanchett likes the idea of deferred income annuities and thinks that they makes sense academically, he admitted that he was expecting them to be the clear “winner”.  But he found that currently, single premium immediate annuities are actually more efficient of a product.  This has a lot to do with them having better pricing because there is so much more competition in the SPIA market.  Since DIAs are relatively new, competition is likely to increase and pricing is likely to become more efficient in comparison to SPIAs.  The Treasury Department ruling making it easier to use deferred income annuities in 401k plans is probably going to significantly increase the demand for DIAs in the future.

To end the interview, they talked about how there are some people who really just don’t need annuity products.  But for those who would benefit from the guaranteed income of an annuity, it’s a good idea to compare single premium immediate annuities and deferred income annuities.  SPIAs and DIAs both offer unique pros and cons that make them useful in some retirement plans and simply not right for others.

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