Deferred Income Annuities (DIAs)
With our increased life expectancies today, one of the biggest concerns on the minds of retirees and those who are approaching retirement is having enough income to last as long as they need it to.
Depending on when you retire, your future income stream may need to last for 20 years or longer. This means that your savings – and in turn, the income that you generate from it – must be stretched out even further.
On top of that, you are likely to incur more healthcare costs as you get older – which in turn means that in addition to paying your everyday expenses, you will also need incoming cash flow to cover the increased cost of care.
One way to help you ensure that income will be there when you need it – even if you live for many years – is to purchase a deferred income annuity or DIA. This type of annuity, which is also often referred to as longevity insurance, will provide you with an income stream later in life, and can protect you financially from essentially living “too long.”
What are Deferred Income Annuities and How Do They Work?
A deferred income annuity is a type of annuity that will provide you with a guaranteed future income stream, starting at a pre-determined future date. In return for either a lump sum contribution or contributions that are made over time, income from a DIA will start to pay out many years (sometimes even up to 30 or 40 years) down the road.
DIAs are oftentimes funded with money from personal savings or investments and/or from funds that are moved over from an employer-sponsored retirement plan or a personal IRA account.
Deferred income annuities are oftentimes used as a type of “pension” income for those who do not (or who will not) receive a pension from their employer, and/or those who may lose pension income due to the loss of their spouse. The income from a DIA can be set up to pay out monthly, quarterly, or even on a yearly basis.
DIAs are typically purchased by those who are in their 50s or 60s, with income slated to begin at age 80 to 85 and providing an income that will continue throughout the remainder of the annuitant’s lifetime, regardless of how long that may be.
While DIAs are relatively straightforward and easy to set up, it is necessary that you follow certain IRS guidelines when you purchase a deferred income annuity. So, working with a financial professional who is knowledgeable about such rules is recommended.
Qualified Longevity Income Contracts (QLACs)
A variation of the deferred income annuity is the QLAC, or qualified longevity annuity contract. A qualified longevity annuity contract is a type of annuity that receives special tax treatment from the IRS.
QLACs are essentially deferred annuities that are funded with money that comes from a qualified plan – such as a traditional 401(k) – or an IRA. The QLAC provides a guaranteed income payment for a pre-determined amount of time (including for life).
But unlike funds that are inside of a traditional IRA or 401(k) plan, QLACs are not required to abide by the IRS Required Minimum Distribution (RMD) rules (as long as the QLAC meets certain IRS requirements). This means that you do not have to begin making full RMD withdrawals when you reach age 70 ½, but rather at age 85.
In order to be exempt from the RMD rules, QLACs must meet certain conditions – which include having a maximum amount of contribution. In 2019, the maximum amount of a QLAC contribution must be the lesser of the following:
- $130,000 for those who have more than $520,000 in an IRA or 401(k); or
- 25% of the December 31, 2018 balance in an IRA or 401(k) plan, for those who have less than $520,000
Having a QLAC can provide you with a good strategy for guaranteeing income in the future, while at the same to deferring required minimum distributions within a traditional IRA or 401(k) plan.
How is the Income from a DIA Taxed?
The income that is received from a DIA will be taxed, based on how the contributions to the contract were paid in. As an example, if you used money that has not yet been taxed – such as that from a traditional IRA or 401(k) plan – then 100% of your income from the DIA will be subject to taxation.
On the other hand, if you used after-tax funds (such as money that you had in personal savings or investments), then only a portion of your DIA income will be taxed. This is because the portion of your income payment that represents a return of your contribution has already been subject to taxation.
Factors to Consider Before Purchasing a Deferred Income Annuity
There are several important factors to consider before you commit to the purchase of a deferred income annuity. First, as with any other type of annuity product, a DIA should be thought of as a long-term financial endeavor – and in return for the guaranteed flow of future income, you may not be able to access your contribution.
In addition, once the annuity’s “free look” period has passed, you will not be able to make changes to a deferred income annuity. With that in mind, make sure that you read over all of the annuity’s “fine print” prior to moving forward.
Depending on the DIA you choose, you may also need to consider that the insurance company may retain your contributions if you pass away early and do not receive the amount that you paid into it.
That being said, because it carries the least amount of risk to the insurance company, choosing the “life only” payout from a DIA will typically offer you the highest payout of any lifetime annuity.
Because there can be a number of “moving parts” with annuities, it is recommended that you discuss all of your potential options with an annuity specialist who can answer your questions or concerns, and who can go out into the marketplace and find the annuity that works best for you and your specific goals.
Is a Deferred Income Annuity Right for You?
While a deferred income annuity can provide you with peace of mind in knowing that you will have a predictable future income stream, these types of annuities are not right for everyone. However, you may be a good candidate for a DIA if you are seeking:
Predictable Future Income
Although no one knows how long they will live, being able to count on a stream of income later in life can allow peace of mind in knowing that income won’t run out. DIAs can be even further customized to provide income for both yourself and a spouse so that neither person has to worry about income running out.
The interest rates that are used by insurance companies that offer DIAs are oftentimes higher than rates on Treasuries or CDs. This is because a portion of your original contribution is returned in each DIA payment, so it can allow for larger amounts of income than if you were counting on just interest from other income-producing financial vehicles. Plus, because DIAs do not have account maintenance or management fees, 100% of your premium goes towards your future income stream. Given that, provided that you live long enough, you can receive a larger income amount.
Security / Safety of Your Contribution
The funds that are inside a DIA are not invested in the stock market, so there is no volatility to be concerned about. In fact, once you have set up a deferred income annuity, the next step is receiving your income in the future. And, because DIAs provide income that is guaranteed for a certain length of time – including the remainder of your life – these products can provide you with added security.
A DIA may also be a viable option for you if you expect to live for a long time. For instance, if longevity runs in your family, and you are in relatively good health, it is possible that you could live beyond your life expectancy. In this case, knowing that you’ll have an income to rely on means that you will have one less matter to worry about in the future.
Where to Find a DIA that Matches Your Future Income Objectives
Because they can provide you with a predictable future income stream, deferred income annuities can be an integral part of your overall retirement planning process. But DIAs can also be somewhat confusing in terms of how they operate, as well as the amount of money you can contribute.
Working with an advisor who specializes in retirement income planning – especially as it pertains to annuities – can help you to ensure that all of your questions and concerns are answered and that you can narrow down which type of annuity could be right for you in meeting your objectives.
At DCF Annuities, we aim to educate consumers on how annuities work – and how they can provide the tools that are necessary for protecting and growing wealth – for both now and in the future.
Want more information on how to secure an income stream that you will be able to count on in the future? Just Contact DCF today and we’ll show you the possibilities.