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SPIAs Trump DIAs & QLACs in Many Scenarios

Have you ever done a comparison of deferred income annuities and single premium immediate annuities? Lately, DIAs have been getting a lot more attention partly because of the Treasury Department making them easier to use in retirement plans. DIAs are getting searched on Google ten times more than SPIAs, but sales of SPIAs are still three times that of DIAs. Both products have benefits that are worthwhile to different individuals and families planning for their financial future. Joe Tomlinson recently wrote an article for the Advisor Perspectives section of ValueWalk titled “Are DIAs Better Than SPIAs – Maybe Not?

Deferred income annuities can be used in two different ways. The first way is to purchase one when you are close to retirement age, but not quite there yet. A 55 year old can buy a DIA that starts paying them lifetime income starting at age 65. That way this money will be protected from market losses close to retirement. The second way is to defer the income payments until very late in life, such as age 85. These DIAs are often referred to as Qualified Longevity Annuity Contracts and are the type that the government is promoting in 401k plans. QLACs are exempt from Required Minimum Distribution rules which is an added benefit. For this article, the author looked at the different situations where people use DIAs and played devil’s advocate to see if a SPIA might work better in that situation.

He first compared deferred income annuities and single premium immediate annuities for a 55 year old who is looking to generate lifetime income at a retirement age of 65. One option would be to purchase a deferred income annuity that will start paying income at age 65 and would also return the premium to an heir if the purchaser died sooner than 65. The second option is to place the money in bonds until age 65 and then purchase a SPIA at age 65. He found that the two strategies, while they seem very different, actually produce nearly the same financial results. Since the DIA won’t get to take advantage of much mortality pooling benefit because it is only deferred at a young age, Tomlinson favors the SPIA in this situation. It offers more flexibility because we don’t often know exactly what age we can retire at, so you can purchase the single premium immediate annuity from the bond funds at your exact retirement age.

Next, he compared the SPIA with a QLAC. Money is used to buy a SPIA at age 65 or to buy a QLAC at age 65 that is deferred until age 85. In the latter scenario, a bond ladder is used to produce income from age 65 to age 85, so the total funds are split between the bond ladder and the QLAC. There is a helpful chart in the article showing how much pre-tax income the purchaser would receive in three different scenarios. The lowest income comes from the QLAC with a Treasury Ladder. A SPIA with a cash refund produces 13% more income and a SPIA without a cash refund produces more than 22% higher income. Now, this last strategy doesn’t offer any liquidity or death benefit, so that is something to consider. While the SPIA with a cash refund offers a death benefit, it also does not have any liquidity. In this situation, the purchaser has to determine what is right for them. You might want to use the last strategy if you still have a lot more retirement resources after purchasing your annuity. If you don’t have a lot of other savings, the QLAC strategy might be best for you.

Michael Kitces recently found that using stocks to finance your retirement is still a profitable strategy. Based on the historical returns, you most often receive as much income as you would with a QLAC and also have benefits to leave to your heirs. The question is if you are willing to bet against that “most often” aspect rather than the guarantee that you get with an annuity product. You also have to account for the fact that the stock market might have lower returns than the historical average dictates. In this case, your stock strategy could be risky and you have to be willing to adjust your plans and accept that you may lose money.

There is a lot of marketing and financial press about DIAs and QLACs lately. These products certainly offer benefits to retirement planners, but they don’t necessarily negate the benefits of SPIAs as some people think. This author found that SPIAs can often be just as or more beneficial than DIAs and QLACs despite the fact that it may be easier to sell the last two products based on the current economic mindset.

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