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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?
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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NY Life for this one, Dave.
Thank God for my pension so I don’t have to deal with annuties!
Lucky bug!
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.
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.
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”. 🙂
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. 🙂
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.
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.
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.
I’m jealous. Pensions aren’t things that my generation can reasonably expect.
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?
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.