Good Reasons to Buy a Deferred Income Annuity

It helps you protect against the risk of outliving your money in retirement.

I understand that the Treasury Department just changed the tax rules so people can now invest IRA money in deferred income annuities without worrying about required minimum distributions. Should I invest in this kind of annuity?

It’s worth considering when you do your retirement-income planning. Deferred income annuities (also known as longevity annuities) have become an increasingly popular way to protect against the risk of outliving your money in retirement, and not having to worry about required minimum distributions will make them even more attractive. With a deferred income annuity, you invest a lump sum in your fifties or sixties and lock in a guaranteed lifetime payout that starts at a later date. Nobody knows how long he or she will live, but having a guaranteed income stream that kicks in after a certain age can help you plan withdrawals from the rest of your savings.

“A 65-year-old married couple has a 60% chance that one spouse will live to age 90 and a 30% chance that one will live to be 95,” says Lee Covington, senior vice-president and general counsel for the Insured Retirement Institute, a trade organization of financial institutions and advisers focusing on retirement income. They can plan their withdrawals to, say, age 85, he says, and then “have a longevity annuity to take advantage of if they’re fortunate enough to live beyond that.”

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The longer you defer the payouts, the bigger the bang for your buck. For example, if you invest $50,000 in New York Life’s Guaranteed Future Income annuity at age 60, starting at age 80 you’ll receive $17,614 each year for the rest of your life. (You’ll get $13,695 per year if you buy a version with a cash refund that promises that your beneficiary will receive at least the amount of money you originally invested if you die before receiving the $50,000 back in payouts.)

The required minimum distribution rules in effect before the Treasury’s ruling made it difficult to make the most of these products. Because you need to start taking money from your traditional IRAs and 401(k)s at age 70½ and pay taxes on the withdrawals, some insurers only let people invest in these products with money from taxable accounts. Other insurers let people invest IRA money in deferred income annuities but required them to start receiving lifetime income before age 70½, and the shorter deferral period limited the value of their investment.

MetLife, for example, offered deferred income annuities in 401(k)s but required payouts to begin at age 70½. People were allowed to invest traditional IRA money in these annuities as long as they agreed to take the required minimum distributions from another account. If they didn’t have another account to tap for RMDs, they had to start taking income from the IRA at age 70. (MetLife allows people using Roth IRA money to defer the payouts as late as age 85, however, because Roths don’t have required minimum distributions.)

The Treasury Department’s new rule would permit people to invest up to 25% of their IRA or 401(k) account balance (or $125,000, whichever is less) in these longevity annuities without having to take RMDs on that money. Because of this change, insurers are expected to extend the deferral age to 80 or 85.

The average buyer of deferred income annuities is about 59 and defers the payouts for seven or eight years, says Joe Montminy, LIMRA Secure Retirement Institute annuity research director. Removing the RMD issue creates an opportunity for people to get higher payouts by deferring longer. Montminy expects that more companies will enter the market and more advisers will start recommending these products.

It may take a few months for state regulators to approve changes to new products from insurers. Insurers are also determining what this means for people who bought these annuities before the rules were changed.

For more information about deferred income annuities and how they can fit in a retirement-income portfolio, see Deferred Income Annuities Offer Predictability.

Kimberly Lankford
Contributing Editor, Kiplinger's Personal Finance

As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.