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.

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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