Imagine if you could set aside $125,000 in retirement savings and have it produce more than $60,000 in annual income. Ordinarily it would take a lifetime of investing gains to achieve that, but a 65-year-old could manage it in 20 years, guaranteed, with a deferred-income annuity.
Also called longevity insurance and longevity annuities, these are insurance products meant to begin paying income years after they are purchased, providing income for retirees late in life. But since the guaranteed payout is largely based on interest rates when the policy is purchased, it’s worth asking whether it would pay to buy now or wait until rates climb higher.
Generally, it pays to buy sooner rather than later, says Ken Nuss, CEO of AnnuityAdvantage, based in Medford, Oregon. That’s because a payout increase from any gain in interest rates could be offset by a shorter deferment — the period from when the policy is purchased until payments begin.
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“The longer the deferral period (years to income start date), the more pronounced this DIA advantage becomes,” Nuss says, adding, “Not to mention the fact that no one can accurately predict where interest rates will actually be several years from now.”
A deferred-income annuity is just what it sounds like — an annuity that pays a set amount starting a given number of years after the policy is purchased, usually with a single upfront payment. DIAs are first cousins to immediate annuities, which start paying right away, but in much smaller amounts. With some exceptions, once the DIA is bought, the money spent is gone — it cannot be withdrawn or left to heirs. It’s an insurance policy, not a liquid investment.
Longevity insurance is a deferred income annuity that typically does not start payments until the policyholder turns 85. It is truly insurance against the risk of living to be very old and outliving your money.
These polices can be purchased through a qualified longevity annuity contract, allowing the buyer to use up to $125,000 from a qualified retirement plan or individual retirement account. There is no tax on a withdrawal for this purpose, so long as the total spent on one or more policies does not exceed $125,000. A withdrawal for this purpose reduces the retirement account, which also reduces the investor’s taxable required minimum distributions in the following years.
Why are these policies so generous?
The payout delay allows the insurer to earn investment returns in the years before payments begin. Though payments continue for the policyholder’s lifetime, a delayed start reduces the number of years they will be made. And the insurer knows that some policyholders will not live long enough to receive many payments, while others will die before receiving anything.
All that allows the insurer to be pretty generous. The website Immediateannuities.com shows that a 65-year-old man spending $125,000 could receive $60,552 a year for life, starting at 85, compared to $8,208 a year if income started immediately.
To get $60,000 a year from age 85 to 100, you’d need a nest egg of over $555,000 at 85, assuming an 8 percent annual investment return and tapping principal so the account was empty at age 100. For a 65-year-old to turn $125,000 into $555,000 in 20 years he’d need to make about 10 percent a year, assuming a 2 percent inflation rate. That could happen but it would be risky to count on it. The DIA payment would be guaranteed so long as the insurer remained solvent.
But because there’s no guarantee you’ll live long enough to receive as much as you’d put into the DIA, or could have made with an investment instead, most experts suggest putting only a portion of the retirement nest egg into the policy. Some believe that despite the generous-looking payouts, DIAs are not necessarily a good option.
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“Longevity annuities are still not ready for prime time,” says Paul Ruedi, CEO of Ruedi Wealth Management in Champaign Illinois. “I find that they cannot compete with investing the money in a low-cost index fund strategy with a 60/40 (stock/bond) allocation globally diversified.”
As mentioned, payouts are determined in part by interest rates. Since insurers invest premiums received, largely in bonds, they can promise bigger payments if they expect bond yields to be higher. Currently, most market watchers expect yields to rise. In fact, yield on the 10-year U.S. Treasury note has already gone to about 2.5 percent from 1.7 percent in the summer.
So, if you want a DIA would it make sense to hold off until yields are even higher?
Most experts say no. One reason is that insurers, though they don’t say exactly how their calculations are made, probably use projections on future yields. So the expectations about higher bond earnings may be built into their calculations already.
Another reason is that waiting to buy a policy means leaving less time for the insurer to invest your premium, another factor in the calculation. Shortening this period reduces the payout.
A 67-year-old putting $125,000 into a policy to begin paying at 85 would get $57,636 compared to the $60,552 for the 65-year-old, according to the ImmediateAnnuities.com calculator.
“One strategy that we recommend when investors are faced with this dilemma is to hedge their deferred-income annuity purchase by laddering their entry dates,” Nuss says. “For example, use one-third of their total intended premium to purchase a DIA now, use one-third to purchase a DIA one year from now and use the final one-third to purchase a DIA two years from now.”
In addition to deciding how much to spend and how long to wait for payments, DIA buyers can choose among various add-ons. The figures above — $60,552 a year for a 20-year deferral — involve a policy that pays nothing if its owner dies before 85. Another option, life with cash refund, returns your premium to your survivors if you die before 85, or, if you die after payments begin, returns the difference between your premium and the payments you’d received. But in exchange for this feature, the annual payments would be reduced to $41,208.
For an even larger reduction in payments, you could get a guarantee the income would continue for five or 10 years after it started, even if you died during that period.
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It’s also possible to get a policy for a couple that will continue paying until the second person dies. Again, the payments will be smaller because, with two people covered, there’s an increased chance payments will flow for a long time.
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Deferred-Income Annuities Are an Option for Late-Life Income originally appeared on usnews.com
