Longevity annuities are getting a lot of attention in 2015, especially for use in 401k plans. They offer unique benefits for retirees, but might not be the right product for everyone’s financial plan. Marketwatch’s Glenn Ruffenach asked “Will you need a ‘longevity’ annuity in retirement?” His article discussed the pros and cons of longevity annuities, also referred to as deferred income annuities or longevity insurance. A deferred income annuity is the more proper name for these products because the key term associated with them is the word “deferred.” While immediate annuities pay you income relatively soon after you purchase them, deferred income annuities often delay your payments for decades. You receive higher payments for less initial premium when you defer the payments over a long period of time.
Deferred income annuities only make up a small portion of total annuity sales, but their sales figures have been steadily increasing over the last couple of years. During the first three quarters of 2014, LIMRA found that deferred income annuity sales were up 35% from the previous year. Only three insurance companies were selling these annuity products just three years ago and now there are more than fifteen companies selling DIAs. Retirement income professor and financial expert Wade Pfau researched deferred income annuities and how they might be used to the meet retirement income needs of Americans. He wrote an article for the Journal of Financial Planning with his research findings.
One of the main advantages to deferred income annuities is that they provide you with a guaranteed income source later in your life. Their value becomes almost as much psychological as it is financial. Many people are worried that they will run out of money in retirement and the income you receive from a deferred income annuity eliminates the worry about longevity risk. People experience cognitive declines in their later years and can become vulnerable to making poor financial decisions. Some experts say that DIAs are a form of “dementia insurance” because you make the decisions about your money when you are younger and likely better able to make cognitive decisions.
There are some disadvantages to purchasing deferred annuities. You give up control of your total premium once you purchase a deferred income annuity, so you need to keep emergency funds elsewhere in your financial plan. While there are inflation-adjusted deferred income annuities, higher than anticipated inflation can still be an issue affecting your level of real income in the future. The downsides of deferred income annuities are the reason that it’s wise not to “put all of your eggs in one basket” and have different products in your financial plan set to cover different needs during retirement.
Pfau’s research found that a deferred income annuity combined with a 20-year TIPS ladder was one of the best strategies for creating income throughout retirement. He compared four different strategies and this one supported a 4.17% withdrawal rate and protected against downside risks. The other three strategies he researched were using a 30-year TIPS ladder, purchasing an inflation-adjusted immediate annuity and using a portfolio of traditional stocks and bonds. In addition to Pfau’s research supporting the importance of deferred income annuities, the Treasury Department has also been lobbying for Americans to purchase them as QLACs within their retirement accounts. Pfau suggests looking into deferred income annuities as a part of your retirement plan if you haven’t yet, because they might offer the right solution to your future income needs.