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Money for Later

David Powell

IF A SALESPERSON had tried to get me to sink my hard-earned money into an investment that’s illiquid or issued by an insurance company, I would have shut down in a New York minute—until now.

My spouse and I recently became owners of a deferred income annuity (DIA), with plans to put perhaps 15% of our savings into these products. Also known as longevity insurance, a DIA involves plunking down money today in return for regular monthly income starting at a future date. What convinced us to buy DIAs?

  • Income hedge. We want income we can’t outlive. The DIAs will provide us with a safety net if the withdrawals from our 401(k), IRA and taxable savings fall short of what we expect or if our Social Security benefits get cut.
  • Shrinking yields. Treasury bonds—both the conventional type and those that are indexed to inflation—are mainstay riskless assets in our portfolio. But today, they yield less than inflation. Yields on municipal and higher-quality corporate bonds are also disappointing, especially when you factor in the added risk involved. By contrast, with a DIA, we can collect handsome income, in part because the insurance company will be effectively returning part of our initial investment to us each month.
  • Longevity risk. Some of us will live much longer than our birth year cohort. It’s impossible to know how life will go, but my spouse and I are keen to stay independent to the end.
  • Simplicity. Our plan is to collect income from annuities and Social Security, while also taking required minimum distributions from our retirement accounts. Put these three together, and we have a simple plan for turning our savings into retirement income. That simplicity will be useful as we age.

My first concern with buying an annuity was the usual—that our chosen insurer could go belly up or fail to generate the income needed to meet its obligation to us. After the 2008 subprime mortgage fiasco, I’m skeptical of ratings agencies. But I used their ratings and my own review of audited financial statements to choose a top-rated insurer for our first purchase. Annuities are not 100% guaranteed by the FDIC or anybody else. But should an insurer fail, our state’s guaranty association provides a mechanism to recover a portion of our premiums.

My bigger concern was inflation. We bought a joint annuity with a 3% annual cost-of-living adjustment. The DIA will pay guaranteed income every month starting when I’m age 72 and ending when the second of us leaves this vale of tears. The 3% inflation rider reflects my bet that inflation will be similar to the historical average.

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Yes, I remember the high inflation of the 1970s. But for a broader perspective, I reread Triumph of the Optimists, which shows annual U.S. inflation averaged 3.2% during the last century. Since then, personal consumption expenditure inflation has averaged less than 3%, according to FRED, the data tool maintained by the Federal Reserve Bank of St. Louis.

What if inflation is much higher in future? With dependable income streams from both Social Security and our DIAs, we can afford to keep a healthy amount of stock market exposure in our investment accounts, which should help if 1940s- or 1970s-style inflation returns.

My last question was about the likely benefits, beyond the peace of mind offered by guaranteed lifetime income, and the costs involved. Ideally, we’ll get back our investment plus a modest rate of return. The two big variables are how long we’ll live and the related issue of opportunity cost—how we would have fared if we’d used the money instead to, say, buy bonds. Bottom line: We have decent odds of breaking even on our DIAs while achieving the main point of our investment, which is hedging longevity risk.

For our DIA purchase, we turned to the same online sellers who offer immediate fixed annuities. The buying process was straightforward, though much slower and more complex than buying a mutual fund. Our purchase took just under two weeks from quote to policy delivery. It would likely have gone faster if we’d used a local insurance agent, rather than buying online. There’s a healthy stack of paperwork involved—less than closing on a house, but far more than a mutual fund prospectus plus a trade confirmation.

If I could change one thing about DIAs, it would be to increase the transparency about the transaction costs involved. We received no cost disclosures similar to those offered by mutual funds. To be sure, all costs are already reflected in the income you’re quoted.

Still, I would like to have known more. For selling an immediate or deferred income annuity, it seems a salesperson might collect a commission of between 1% and 5% of the sum invested. That’s certainly high compared to index fund costs. But it’s a lot less than other annuities, notably variable annuities and equity-indexed annuities, which between them have given annuities such a bad reputation.

David Powell has written software or led engineering teams for 36 years. He enjoys work, vegan fine dining, cycling and travel with his spouse. His previous articles include Beat the Cheats, Get Me a Margarita and Making a Mesh.

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David Powell
David Powell
10 months ago

NY Life for this one, Dave.

IAD
IAD
10 months ago

Thank God for my pension so I don’t have to deal with annuties!

David Baese
David Baese
10 months ago

I really don’t want to buy insurance from a company that loses money. Their right to a reasonable compensation and profits also secures my investment.

David Powell
David Powell
10 months ago
Reply to  David Baese

Agreed. The ideal insurers in my evaluation were in the top tier of financial strength and have been that way for a long time. I debated whether it matters over the long haul to choose a mutual insurer vs publicly traded.

Langston Holland
Langston Holland
10 months ago

Great article. I like your approach.

Your reference to the “vale of tears” is more relevant than many may know. It comes from Psalm 84:6 and originally applied to the living that successfully navigated hard times and made it into “a place of springs”. 🙂

David Powell
David Powell
10 months ago

Thanks, Langston. It’s been a rather anguished process of deciding to invest but it seems to fit well with the rest of what we’re doing. Your mileage may vary.

It was hard to reason over the uncertainty around longevity as a factor in valuing this. Some longevity calculators give a sense of the odds based on our habits and situation (birth year, education, diet/exercise, etc). For giggles, I also leveraged work on our family tree. Went through three generations of ancestors looking at actual vs expected longevity.

I heard that phrase often from my beloved father-in-law who successfully navigated hard times and is in a better place. 🙂

Steve Chen
Steve Chen
10 months ago

One of our subscribers built their own retirement paycheck through a combination of
1) Social Security Optimization
2) SPIAs
3) Fixed income ladder for RMDs
4) 80/20 portfolio for hedging inflation

Podcast: https://www.newretirement.com/retirement/podcast-episode-41-glen-nakamoto-building-retirement-paycheck/

Article: https://www.newretirement.com/retirement/establishing-retirement-income-using-an-income-floor/

Would love your thoughts on his approach.

David Powell
David Powell
10 months ago
Reply to  Steve Chen

There’s a lot to unpack in that article, but some of Glen’s concerns and the plan he built are similar to mine. I’m not yet retired so we went with deferred income annuities to put the money to work now and we opted for a 3% COLA.

R Quinn
R Quinn
10 months ago

A steady income stream is so important. I can’t imagine the stress without a good pension … or more money than you could ever spend no matter what. Building an income steam from a combination of sources including an annuity seems the way to go.

Ryan
Ryan
10 months ago
Reply to  R Quinn

I’m jealous. Pensions aren’t things that my generation can reasonably expect.

james mcglynn
james mcglynn
10 months ago

The deferred income annuity is about as close as possible to a “personal pension”. I assume this wasn’t a QLAC since it pays till the spouse is deceased as well?

David Powell
David Powell
10 months ago
Reply to  james mcglynn

Hi James. Yes, that “personal pension” concept was what we were going for. Our fathers each had a pension. My spouse and I were in the first 401K generation.

We bought ours with post-tax dollars so not a QLAC if I understand that right. We bought ours joint so the longevity bet is on the last of the two of us to go.

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