Annuity FYI Overview
A deferred income annuity (“DIA,” and also sometimes referred to as a longevity annuity), is a contract between a client and an insurance company. The client gives 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 they will receive. The payouts are pre-determined as well, and is a guarantee from the insurance company. When they sign the contract, they decide when they want to start receiving income, and the insurance company will guarantee a set income. Most deferred income annuities allow for subsequent contributions to their 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 a client invests in a deferred income annuity, they 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:
James 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, James 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 James 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, the client will forfeit the principle in exchange for the guarantee of future payments. Some insurance companies offer optional riders that can be added to a deferred income annuity to pass on their investment to their heirs when they die – depending on the annuity, either return of the initial premium, or an income stream for a guaranteed period.
Some insurance companies also offer optional benefits that increase the 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 the client’s lifetime, or the lifetime of the joint annuitant, whichever is longer. With a period certain guarantee, payments are guaranteed for a set length of time to your client and potentially their beneficiary, should they pass during the guaranteed period. Lastly, a period certain with cash refund option guarantees a stream of income for a set length of time, and should they pass away during that time, the sum of the payments for the rest of the period would be given to the heirs upon death.
These various options come at an additional fee, which reduces the income payments, so be sure to mention this to clients.