Deferred income annuities (DIAs) can help you insure against the possibility of outliving your assets in retirement.
DIAs can offer the same level of benefits after the deferral period as immediate annuities for a much smaller up-front payment.
DIAs generally aren’t liquid so you can’t withdraw their value as cash, but knowing that you’ll get a guaranteed income for life could free you to keep more of your other savings invested.
Worried about outliving your savings? Annuities can help by providing a guaranteed stream of income for life—and the life of your spouse.
One challenge for the annuities-curious is that there are many different kinds of annuities, as well as a variety of ways to customize each contract using special riders and other add-ons, and they all work differently. Here we’ll focus on deferred income annuities, or DIAs. (You can find articles about other kinds of annuities here.) It’s also important to note that all annuity guarantees, including an annuity's payment guarantees, are subject to the claims-paying ability of the insurer.
With a DIA, you hand over a chunk of your savings—either as a single lump sum or in multiple payments over time—to an insurer. In return, you get a lifetime series of payments. As the name “deferred” implies, these payments start sometime in the future, say anywhere from 13 months to 40 years from the start of your contract.
For example, you could buy a DIA at age 65 and not start taking payments until you hit 85. The appeal is that you can lock in a regular source of income (along with Social Security) to insure against the possibility of running out of money as you age. You’re also effectively shielding a source of income from the volatility that comes with staying invested in the market.
It may sound strange to hold off taking benefits until such an advanced age, but that’s also when financial challenges could become more acute—particularly the risk that you could run out of money if you live a long time. Knowing that you can have a certain amount of income to rely on deep in retirement can give you some additional peace of mind.
Deferring for growth
The deferral period distinguishes DIAs from the perhaps more familiar immediate annuity. With an immediate annuity, you pay the insurer and, as the name implies, your income payments start right away.
So why wait? Generally, the longer you defer, the bigger your eventual payments (though your age and current interest rates are also a factor). In practice, that means you can get the same monthly payment without having to commit as much money as you would with an immediate annuity—as long as you’re able to wait.
For example, imagine a 65-year-old man who wants a guaranteed monthly income of $3,000 from an annuity. With an immediate annuity, he could hand over a $623,172 lump sum today and start receiving a monthly payment of $3,000 right away.1 With a DIA, he could get a $3,000 monthly payment for about $113,000, with the payments starting at age 85.2
This table, created using Schwab’s Annuity Income Estimator, shows how the initial investment needed for a set amount of money drops the longer you stretch out the deferral period.
|Deferral period||Date payments begin||Amount needed to purchase $3,000 of monthly income|
Looking at it another way, if a 65-year old man placed $120,000 into an immediate annuity, he would get about $579 a month in payments. However, if he put the same $120,000 into a DIA that started making payments at age 85, he could get just shy of $3,000 a month.3
In other words, if you do some advance planning and are able to lock up some money while you wait for the benefits to start, you can secure some peace of mind for later in retirement. And because the initial investment would be smaller than if you’d gone with an immediate annuity, you could choose to keep more of your remaining savings invested in the market for growth.
As with any investment, DIAs come with some tradeoffs.
- DIAs generally aren’t “liquid” investments. Once you invest, the money is locked in, so you usually can’t withdraw the money in a lump sum if you need it back. A DIA rarely has an immediate cash value, so you have to weigh the benefits of future income against the fact that you might not be able to cash it out in an emergency.
- If you die before payments begin, the DIA investment will be forfeited. However, there are ways around this. In exchange for accepting a lower annuity payment, you could add on a return of premium or cash refund rider that would ensure that your original investment, less any payment to you, would be paid out to a beneficiary. DIAs can also be structured to cover a spouse to guarantee lifetime income, though, again, that generally reduces the monthly payment.
- DIA benefits are, in part, calculated by the insurance company using interest rates, which happen to be relatively low right now. Investors who are concerned about locking in payments at the current rates could consider making multiple investments in a DIA over time. Annuity income payments from the DIA are based on rates at the time each individual purchase payment is made. If interest rates increase over time, you could effectively “dollar cost average” into different annuity payout rates. It’s also worth noting that it wouldn’t necessarily make sense for someone, say, in his or her 40s or 50s to commit a lot of funds all at once to a DIA in preparation for the future. The investor could potentially earn bigger returns by investing in the stock market over the long term. Additionally, if an investor had a big change in life expectancy due to a health change, the attraction of an income stream that didn’t start until years later could be diminished.
- DIA payments are fixed when the payment is made and don't adjust with inflation, so it's important to remember that the future purchasing power of a given monthly payment may not be as strong as it is today. That said, you can also get an inflation rider that would allow payments to rise with inflation once payments begin. This generally means accepting lower income, and keep in mind that the inflation benefit doesn’t adjust during the deferral period.
Retirement planning help
Planning for retirement can be challenging. The sooner you start planning, the sooner you can figure out if you’re on the right track. Adding a DIA to your overall retirement portfolio may be one way to ensure that your retirement income lasts as long as you do.
1Assumptions: Single Life Male, born 1/1/1952 (age 65). State: New York. Monthly income: $3,000. Income Option: Life with cash refund (This means you will receive this income for life. Your beneficiaries will receive a lump-sum payment of the original Beneficiaries will receive a lump-sum payment of the original investment less income payments made to date.). Data as of 08/02/2017.
Note: In order to simplify this example, we have made additional assumptions that result in the numbers presented here. Estimates provided are not binding and are subject to additional considerations, including taxes, that may result in a higher or lower payout. Please contact a Schwab representative for more information. See additional important disclosures. Guarantees depend on the claims-paying ability and strength of the issuing insurance companies (not Schwab). An income annuity has no cash value. Once issued, it cannot be revoked, and the initial investment is not refundable and cannot be withdrawn or exchanged for another annuity. Joint and survivor life options may reduce the current income payment upon the death of the primary annuitant.
2This example is for illustrative purposes only. Some contracts may not allow distributions to start past the age of 85. Shorter deferral periods would result lower monthly income.
3Assumptions: Single Life Male, born 1/1/1952 (Age 65). State-New York; Income Option: Life with cash refund (This means you will receive this income for life. Beneficiaries will receive a lump-sum payment of the original investment less income payments made to date.) Data as of 08/02/2017.
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