Waiting Game

Dennis Ho

HOW DO DEFERRED income annuities work and how do they fit into a retirement portfolio? I’m a fan of DIAs—sometimes also called longevity insurance—because of their simplicity and range of benefits. Indeed, I sell them through the insurance website I run. But I also realize they aren’t for everyone.

With a DIA, you hand over a lump sum to an insurer in exchange for regular income payments. Like a standard lifetime income annuity, the payments are guaranteed, no matter what happens in the markets or how long you live. With a DIA, however, the start date for your payments is deferred at least a year and often far longer.

By delaying the payment starting date, DIA buyers can receive higher income, because insurers get to invest the funds for longer, plus buyers collect “mortality credits.” What are mortality credits? That refers to the fact that some DIA buyers will die young and their funds can then be used to make higher payments to those who live longer.

For example, a 65-year-old man investing $100,000 in a DIA could receive some $24,000 a year in guaranteed lifetime income starting at age 80, compared to $6,300 a year if he bought an annuity that starts paying immediately. Obviously, by the time the DIA starts at age 80, the immediate annuity would’ve already paid out a heap of money—$94,500. But in terms of total dollars collected, our 65-year-old DIA buyer makes up that lost ground by age 86. If he lives longer than that, the DIA starts pulling far ahead of the immediate annuity in terms of total income. (One nerdy point: If you figure in the time value of money—the fact that the immediate annuity pays you back sooner—the breakeven would be somewhat later.)

In effect, a DIA lets you maximize your income for your later years, while providing protection against both a financial market downturn and the risk that you run through your other retirement savings. A DIA can also help simplify the management of your remaining assets, because you have more certainty about your future income.

One possibility: A 65-year-old couple could purchase a DIA to cover all the income they’ll need starting at age 85 and then spend down their remaining assets over the intervening 20-year period. Alternatively, let’s say you have some other sources of guaranteed income, such as Social Security and a defined benefit pension. You might buy a smaller DIA to supplement this income in later years, thus helping to offset the corrosive impact of inflation on your pension’s fixed payments, while also ensuring you have extra income if you face higher medical expenses later in life.

Another way to use DIAs: Help with the transition to retirement. Imagine a 55-year-old woman who invests $10,000 a year in a deferred annuity, with payments starting at 65. Based on today’s rates, her $100,000 investment over 10 years would generate income of $7,500 a year starting at 65. By contrast, if she’d invested the full $100,000 at 65, she’d receive $5,950. Once again, the purchaser benefits from the mortality credits collected during the deferral period and she gets rewarded for letting the insurer use her money for longer. Other benefits of this strategy: It allows you to dollar-cost average into an immediate annuity, potentially protecting part of your portfolio from a severe market downturn prior to retirement.

DIAs have many uses and benefits—but they aren’t perfect. During the deferral period, you forgo the returns you could have earned with other investments, plus the promised payments will have less spending power, thanks to the intervening inflation. Also, there’s the risk you die young—and you’re the one who ends up subsidizing the mortality credits collected by others. If you pass away before a DIA starts paying, you lose your entire principal. DIAs are available with return-of-premium features, but that heavily diminishes the value of the product and means you should probably consider other strategies instead.

In addition, DIAs can make tax planning more complicated. With income annuities, a portion of each payment is considered interest and hence it’s taxable. Because DIAs have a higher interest component, a larger percentage of your payment will be taxable. When evaluating immediate and deferred income annuities, be sure to look at both the gross and taxable income. Both are available with any quote.

One final consideration: There’s the so-called counter-party risk—the risk that the insurer won’t be around to make your annuity payments. To limit this risk, buy from large insurers with a high rating for financial strength, and consider purchasing DIAs from multiple insurers.

Dennis Ho is a life actuary who has spent 20 years in the insurance industry in a variety of actuarial, finance and business roles. His previous articles include End GamePolicy Decisions and Works If You Can’t. Dennis can be reached via LinkedIn.

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David J. Kupstas
David J. Kupstas
3 years ago

Longevity insurance is a great idea, but it is a tough sell for most people. It’s the same as encouraging people to wait ’til 70 to take Social Security. People will argue that you come out ahead commencing early unless you live past age X. I say, who cares? The point is you’re trying to cover yourself if you have the good fortune of living to an advanced age. This assumes you have the financial ability to forgo the income in your 60s. If you need the money then – or can’t pay the premium on the deferred annuity – the analysis changes.

Roboticus Aquarius
Roboticus Aquarius
3 years ago

I only consider SPIAs (or SPDAs in this case) – is a DIA the same as a single premium deferred annuity?

I’m going to quibble over your comparison of amounts. First, that’s a pretty low return for investing on one’s own. Secondly, the point of a SPDA is insurance, not to match investment returns. If all I’m worried about is maximizing my returns, I’ll invest it myself in virtually every situation. If I’m worried I’ll live 20 years longer than I originally planned, an SPDA is wonderful insurance against running out of cash.

I am not sure I got the “DCA into an immediate annuity” comment, I think you meant assuming one is purchasing it in installments from age 55 to age 64? That’s an interesting thought, though I think if you’re trying to build equity towards retirement that will slow you down somewhat, so it sounds like a trade-off you might only want if you are ahead of your savings targets?

I very much consider SPDAs a great piece of insurance. If I’m still alive in my late 60’s or early 70’s I expect to purchase one for my mid 80’s and on. That trade-off strongly appeals to me.

Dennis Ho
Dennis Ho
3 years ago

Hi @Roboticus Aquarius:disqus,

Thanks for the comment. So to address your questions:

1) Yes, the DIA here is the same as a SPIA, with the only difference being the start date. SPIAs technically have to start within 13 months, DIAs start after 13 months.

2) The main goals of Both DIAs and SPIAs are insurance from outliving your money, so agree returns on either are not going to be anywhere near equity-like, nor is maximizing returns the goal of either product.

3) If I’m age 65 and worried about outliving my money, there are a couple of different strategies using either SPIAs or DIAs, or both. e.g. I think there is a lot of merit to a strategy of buying a DIA at age 65 that starts at age 85, then spending down my other assets from 65-85 vs. buying a SPIA at age 65. But either strategy could work. Happy to discuss in more detail via email if you like.

4) The 55-65 example was really meant to highlight how you could use DIAs to average into retirement income vs. waiting until 65 to buy a SPIA. Agree if the stock market does well from age 55-65, you’re probably better off waiting. But you’re exposed to sequence of returns risk and the risk that interest rates are way down when you reach age 65. If you spread your annuity investments over 10 years, you’re able to de-risk as you get closer to retirement and average your purchases over a longer period. As with all strategies, it really comes down to your goals and risk tolerance which one you choose.

I’m not sure I understand your “low return” comment in the second paragraph? I wasn’t intending to position DIAs as a high-yielding asset, so happy to clarify any points that implied that.

Sanjib Saha
Sanjib Saha
3 years ago

Thank you Dennis for the balanced write-up of DIA. I like DIA/SPIA for the diversification aspect. I also think that one should explore deferring SS beyond FRA before considering DIA. Would love to hear your take on it.

About the “there’s the risk you die young” comment, I personally do not see it as a risk per say as long as the person realizes that the main reason for DIA is to address monetary shortage risk during their lifetime. If one dies, there is no monetary risk that the person needs to worry about anymore :). It maybe a risk for those left behind, but a plain single-life annuity was not bought for them in the first place.

I also think that purchasing-power protection is a major consideration, and ideally it should be there by default in immediate/deferred fixed annuities. If inflation-protection reduces the payout a lot, then a DIA ladder may be an alternative (e.g., a large portion put in the earliest DIA and smaller portions put in a few additional DIAs whose payout start a few years later). Do you have any specific suggestions for the purchasing power risk of fixed annuities?

Dennis Ho
Dennis Ho
3 years ago
Reply to  Sanjib Saha

Hi @Sanjib Saha:disqus,

Yes, agree with you on deferring SS as the first option. That seems to be the best deal around, so I always advise folks to look at SS first. It’s only if SS along with any pensions they have are not enough to cover their core expenses that I advise anyone to look at SPIAs and DIAs.

The inflation point is one I’ve debated with a lot of folks. I agree it’s a key risk but covering it with a SPIA extracts a heavy price. e.g. currently, a $100k SPIA for a 65yr old man pays $511 w/o inflation and $371 w/3% inflation. That means you’d have to pay 38% more upfront to get the same income today if you wanted 3% inflation protection. I think the main driver of this is that TIPS are the main assets insurers can invest in to cover inflation, so when you purchase an inflation-indexed SPIA, you’re tilting the portfolio more towards government bonds, which reduces your yield and increases your price. I personally would purchase a SPIA/DIA w/o inflation and invest the 38% savings in higher-growth assets that hopefully beat inflation (e.g. stocks). I’d then buy another SPIA / DIA every 5 years or so to cover inflation. Definitely more risky vs buying the protection upfront, but I personally think its a more efficient strategy. Happy to discuss further if more questions. You should also feel free to use our website to get different annuity quotes if you’re interested in the pricing –

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