What is a Deferred Income Annuity?
A deferred income annuity (“DIA,” and also sometimes referred to as a longevity annuity), is a contract between you and an insurance company. You give a lump-sum payment to the insurance company in exchange for guaranteed lifetime income that begins at a future date, up to forty years later in some cases. Deferred income annuities can serve as a sort of pension for those investors without an employer’s defined benefit plan.
Advisor Insight
Andrew Murdoch
Certified Financial Planner™
A deferred income annuity is a plan that will help you create a stable income stream for the future. These plans are the equivalent of buying a pension for yourself, or yourself and your spouse. With these plans, you are giving up your principal in exchange for an income stream for life or a set period of time. These plans are growing in popularity due to the fact that pensions are not as prevalent as they have been in the past.
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What is a Deferred Income Annuity?
Annuity FYI Overview
A deferred income annuity (“DIA,” and also sometimes referred to as a longevity annuity), is a contract between you and an insurance company. You give a lump-sum payment to the insurance company in exchange for guaranteed lifetime income that begins at a future date, up to forty years later in some cases. Deferred income annuities can serve as a sort of pension for those investors without an employer’s defined benefit plan. Deferred income annuities work similarly to immediate annuities, except that the payments don’t start immediately.
As with immediate annuities, with deferred income annuities, the rise and fall of the stock market does not affect the amount of future income you will receive. When you sign the contract, you decide when you want to start receiving income, and the insurance company will guarantee you a set income. Most deferred income annuities allow for subsequent contributions to your investment, but the way they are factored into future income varies from one product to another. It often depends on the frequency of the subsequent contributions.
It is important to note that deferred income annuities are not liquid investments. When you invest in a deferred income annuity, you completely forfeit the initial premium. There are several products that have some liquidity options, however, they can be difficult to invoke and are often subject to surrender fees.
Higher Payouts Than Immediate Annuities
Deferred income annuities offer significantly higher payouts than immediate annuity counterparts. Consider the below example of a hypothetical 60-year old considering an investment in a deferred income annuity versus an immediate annuity:
Stewart is 60-years-old, nearing retirement and expects to follow in his parents’ footsteps and live into his 90s. He decides to invest $100,000 in a deferred income annuity, and he wants the payments to start at age 80. At the time of this writing, after the 20-year deferral period, Stewart will be able to withdraw around $42,000 per year for the rest of his life. So, if he lives to age 95, he will have received $630,000 in income from his initial $100,000 investment!
Now what if Stewart decided instead to wait until he is 80-years-old and invest in an immediate annuity. Let’s assume that the $100,000 he had at age 60 was invested in conservative investments yielding 3% interest per year for that 20 years, so by age 80 he had about $180,000. At the time of this writing, an 80-year-old investing $180,000 will receive about $1,500 per month, or about $18,000 per year, from an immediate annuity. So, if he lives to age 95, he will have received about $270,000 in income.
Optional Benefits
With most deferred income annuity base products, you forfeit the principle in exchange for the guarantee of future payments. In order to pass on your investment to your heirs in the event of your death, some insurance companies offer optional riders that can be added to a deferred income annuity to pass on your investment to your heirs when you die – depending on the annuity, either return of your initial premium, or your income stream for a guaranteed period.
Some insurance companies also offer optional benefits that increase your guaranteed income, at a fixed or variable rate, to hedge against the effects of inflation.
Some deferred income annuities only offer a stream of income that is guaranteed for life. Others may offer different and more flexible payout options, such as joint-life, a period certain guarantee, or a period certain guarantee with cash refund. With a joint-life option, payments are guaranteed for your lifetime, or the lifetime of the joint annuitant, whichever is longer. With a period certain guarantee, your payments are guaranteed to you for a set length of time, or your heirs should you pass during the guaranteed period. Lastly, a period certain with cash refund option guarantees you a stream of income for a set length of time, and should you pass away during that time, the sum of the payments for the rest of the period would be given to your heirs upon your death.
These various options come at an additional fee, which reduces the income payments, so be sure to review them with a financial adviser that specializes in annuities.
Deferred income annuities are attractive to many investors because they offer higher payouts than immediate annuities, and give peace of mind of lifetime income. However, as with all investments, the appropriateness of deferred income annuities varies from person to person.
