Understanding Deferred Income Annuities

Written by Hersh Stern Updated Thursday, July 9, 2015

Deferred Income Annuity

A Deferred Income Annuity (sometimes referred to as an "Longevity Annuity") may be the right annuity for you if you are looking for payments that begin at a future date (from two to thirty years hence) and continue for the rest of your life or for a specified period of time. The annuity is purchased from an insurance company with either a single lump sum amount called a premium, or with multiple deposits over time.

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How does a deferred income annuity work?

In return for your lump sum, the insurance company promises to make regular payments to you (or to a payee you specify) starting at a specified date for the chosen length of time – most commonly for the remainder of your life, however long that may be.

When choosing a deferred income annuity, you can choose how frequently you receive payments – often referred to as the “mode.” While deferred income annuity buyers typically choose to receive payments monthly, you may choose quarterly or even yearly instead.

In today’s deferred income annuity marketplace, there are a number of ways the annuity can be customized to suit your specific life situation and concerns. In exchange for the guarantee of payments, you give up the right to demand the return of your original premium. Unlike some forms of life insurance or other types of annuities, you are generally unable to revise or cash in the deferred income annuity once the 10-day "free look" period has passed.

You can fund your deferred income annuity in a number of ways, including:

1. Cash from a maturing Certificate of Deposit (CD).

2. Exchanging monies accumulated in a Deferred Annuity account.

3. Proceeds from the sale of stocks, bonds, a home or a business.

4. A lump sum distribution from a tax-qualified defined benefit or 401k, Traditional IRA, or a Roth IRA account.

Why should I consider buying a Deferred Income Annuity? What are its advantages to me?

A deferred income annuity comes with many important advantages. Here are just a few:

Security

The annuity provides stable lifetime income which can never be outlived or which may be guaranteed for a specified period. This advantage is crucially important to annuitants who may have previously feared outliving their savings.

Simplicity

An annuity is pretty much “get it and forget it.” Once it is set, the only work you are required to do is collect your regular payments. With a deferred income annuity, you do not need to watch markets or track interest rates and dividends.

Higher Returns

The interest rates used by insurance companies to calculate deferred income annuity income are generally higher than CD or Treasury rates. Since part of the principal is returned with each payment, greater amounts are received than would be provided by interest alone.

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Preferred Tax Treatment

A deferred income annuity may be a good strategy to defer taxes until later in your retirement when you may be taxed at a lower rate. This differs from other types of annuities for which the tax burden is “front loaded.”

Safety of Principal

Funds are guaranteed by assets of insurer and not subject to the fluctuations of financial markets.

No sales or administrative charges

Deferred income annuities do not have annual account management or maintenance charges. 100% of your premium goes towards your monthly income.

How can you customize a deferred income annuity?

You may hear a lifetime deferred income annuity called by a number of different names, including "Single Life," "Joint Life," "Life and Period Certain", or "Refund" annuity. Regardless of its name, by ensuring that you will never outlive your income, a life annuity is a powerful retirement planning tool. What’s more, a life only annuity generally offers the highest payout of any lifetime annuity, because it carries the smallest risk for the insurer.

When you shop for a deferred income annuity, you will find that one of the key factors in pricing is your age and life expectancy. In a sense, purchasing a deferred income annuity is like making a bet with an insurance company about how long you will live. Since the insurer will stop making payments when you die, it is betting that you won't live beyond your life expectancy. On the other hand, if you live longer than predicted, your return may be far greater than estimated.

Deferred income annuity coverage can be increased by including a second person ("Joint and Survivor" annuity), by adding a guaranteed period of time ("Period Certain" annuity), or by guaranteeing that payments will continue at least until the original purchase amount has been paid out ("Refund" annuity). This added risk to the insurer is likely to reduce monthly payments by about 5% to 15%, depending on the age of the annuitants and the length of the guarantee period.

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You may want to consider a deferred income annuity with special options if:

1. You wish to guarantee lifetime income for both yourself and a spouse ("Joint and Survivor" annuity)

2. You want payments to continue for a specified period (e.g. 5 or 10 years or more) to a designated beneficiary ("Certain and Continuous" annuity)

3. You want to ensure that should you die before your initial principal has been distributed, an amount equal to the balance of the deposit continues to a named beneficiary ("Refund" annuity).

What about funding my annuity? Can you explain the difference between qualified and non-qualified funds?

The way your annuity payments are taxed depends upon the source of the funds you use to purchase it.

Qualified Deferred Income Annuities

When applied to deferred income annuities, the term qualified refers to the tax status of the source of funds used for purchasing the annuity. These are premium dollars which until now have "qualified" for IRS exemption from income taxes. The whole payment received each month from a qualified annuity is taxable as income (since income taxes have not yet been paid on these funds). Qualified annuities may either come from corporate-sponsored retirement plans (such as Defined Benefit or Defined Contribution Plans), Lump Sum distributions from such retirement plans, or from such individual retirement arrangements as IRAs, SEPs, and Section 403(b) tax-sheltered annuities, or Section 1035 annuity or life insurance exchanges.

Non-qualified Deferred Income Annuities

Non-qualified deferred income annuities are purchased with monies which have not enjoyed any tax-sheltered status and for which taxes have already been paid. A part of each monthly payment is considered a return of previously taxed principal and therefore excluded from taxation. The amount excluded from taxes is calculated by an Exclusion Ratio, which appears on most annuity quotation sheets. Non-qualified annuities may be purchased by employers for situations such as deferred compensation or supplemental income programs, or by individuals investing their after-tax savings accounts or money market accounts, CD's, proceeds from the sale of a house, business, mutual funds, other investments, or from an inheritance or proceeds from a life insurance settlement.

+Additional Frequently Asked Questions About DIAs

Q: What is a Deferred Income Annuity?

A: A Deferred income Annuity (also known as a Longevity annuity or an Advanced Life Income annuity) is a type of annuity contract which allows you to guarantee a future income stream many years in advance of retirement, at a pre-determined future date you choose. You can buy such a deferred income annuity at age 50, for example, and have your payments begin at age 80, three decades later.

Q: Is it a “single premium” or “flexible premium” annuity?

A: Deferred Income Annuities ('DIA') can be purchased with either a single lump sum premium payment or with multiple payments over time (so-called flexible premium purchase). While most deferred income annuity contracts permit subsequent deposits it is important to review the company’s rules about how often you can contribute additional funds and how the company calculates the additional income that is purchased from these later premium deposits.

Q: What are the available payout options?

A: Most DIAs guarantee income payments for the duration of the buyer's lifetime. Some companies also offer joint-life, period certain, and installment or cash refund payout options. Joint-life income options provide guaranteed income payments to you for life or for the life of the named survivor, whichever is longer. Period certain provides guaranteed income for a specified time frame. Should you die during this specified time, the remaining income payments will be paid to your named beneficiaries.

Q: How does the insurance company determine my monthly payment?

A: First and foremost, by delaying the start date these annuities provide you a higher income payment than immediate annuities for the same premium deposit. The amount of income guaranteed is based on the premium amount invested, current interest rates, the length of the delay (deferral) period, and the particular payout income options chosen (period certain or lifetime).

Q: What about inflation?

A: Most DIA contracts offer an optional inflation protection feature which increases your income stream each year by changes in the Consumer Price Index or by a pre-determined cost of living adjustment. This can help to protect the effective buying power of your future income payments. With this rider, your guaranteed income payments will increase annually based upon the CPI or the percentage rate chosen (1% to 6%) at the time of application.

Q: What happens if I pass away before my payments begin?

A: Most DIAs offer an optional rider which pays a death benefit payment to your named beneficiaries if you die before your payments begin (i.e., before the deferral period ends). This allows for either a lump-sum return of the initial premium or sometimes a lump sum return of your initial premium plus interest (as high as 3.00% for each year your annuity was in deferral). Without such a rider, your premium would be forfeited in the event of your untimely death prior to the time your income payments begin.

Q: Am I able to change the date when my payments begin?

A: Many DIA contracts make you choose your predetermined payment start date at the time of purchase. However, some contracts allow you to alter your payment start date even after your annuity has issued. For example, some companies allow you to move your payment date forward or back by as much as five years. Moving the payment date forward would decrease your payment amount, while moving it back would increase your payment amount.

Q: What if an emergency arises and I need to access some extra money?

A: Some DIA contracts offer limited liquidity features, which allow the owner to request some payments in advance to cover unexpected financial situations.

Q: Is a Deferred Income Annuity a safe investment?

A: DIAs offer a high degree of safety. Your premium is guaranteed by the issuing insurance company. Insurance companies are legally required to set aside assets (known as “reserves”) to cover potential claims made by their policyholders. Insurance companies are monitored by rating agencies such as A.M. Best, Standard and Poor’s, and Moody’s. By reviewing the ratings an insurance company receives from these agencies, you may be able to determine if it is operating on a sound financial footing.

For quotes and answers to your annuity questions call 800-872-6684.

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Comments (14)

  1. Michael:
    Feb 02, 2015 at 01:54 PM

    Just what kind of annuity is this? Is this a variable annuity?

  2. Hersh Stern:
    Feb 02, 2015 at 02:16 PM

    Hi Michael,

    These annuities are not variable annuities. They are “Deferred Income” annuities. The amounts in a deferred income annuity are fixed and guaranteed.

    There is no “variability” or indexing of the monthly income amounts the insurance companies will pay you. Variable annuities are annuities where your premium is invested in mutual-fund-like or bond-like sub-accounts and where the amount of the monthly payments you receive may go up or down.

    -Hersh

  3. George:
    Mar 11, 2015 at 03:54 PM

    I’m 51 years old. I see your quotes for age 65. If I waited 16 years to start monthly payments when age 67 instead of 65, does that increase the payments? Would I need to see a whole other set of quotes?

  4. Hersh Stern:
    Mar 11, 2015 at 04:08 PM

    Hi George-

    Yes, for every year that you delay receiving income from your annuity, your eventual monthly payment amount increases. So if you bought the annuity at age 51 and waited to receive income until age 67, your monthly payments would be greater than if you started receiving income at age 65.

    If you’d like to get a personalized quote report with exact numbers for both starting ages, visit the annuity calculator on our home page.

    Hersh

  5. Rosa:
    Mar 12, 2015 at 09:17 AM

    I’m thinking about investing in an annuity that will give me income in 10 years. I’ve read about index annuities with income riders and deferred income annuities. I’m confused about which is better for me. What are the pros and cons of each?

  6. Hersh Stern:
    Mar 12, 2015 at 09:32 AM

    Hi Rosa,

    You're asking a very popular question. Both types of annuities can generate an income stream starting at a future date. In fact (and I’m about to tell you something you’re not likely to hear from other agents) the income streams they both produce are virtually the same. So that should not be the deciding factor. Here are the pros and cons of each product type, as I see it:

    Deferred Income Annuity (DIA)

    Pros
    - Offered by many of the top-rated insurance companies like New York Life, Mass Mutual, Guardian, and MetLife.
    - More varied annuity payment options (single and joint life with period certain or refund options)
    - Very few bells and whistle, the product features are easily understood
    - No fees

    Cons
    - Less liquidity than an indexed annuity. For example, you cannot surrender your contract. Once you buy the DIA , you are locked into the income stream.
    - Less flexibility with your income start date. You must elect your income start date at issue, and you can only change that one time.

    Indexed Annuity with Income Rider (also known as a “Hybrid Annuity”)

    Pros
    - More liquid than a deferred income annuity. You can surrender your contract and pull your funds out. Keep in mind that you will be charged surrender fees during your surrender charge period.
    - More flexibility. For example, you don’t select the income start date when you buy the annuity. You choose when you would like to start receiving income whenever you want.

    Cons
    - Many of the competitive indexed annuities with income riders are offered by lesser-rated insurance companies. For example, New York Life, Mass Mutual and Guardian Life do not offer fixed index annuities.
    - These products can be very complex, making them difficult to fully understand
    - There’s usually an annual rider fee of 0.50% – 1.00%

    I hope this summary helped.

    -Hersh

  7. Linda:
    Mar 31, 2015 at 09:41 AM

    Can I buy a deferred income annuity that ties to index performance? i.e. if the market is up, I can participate in the gain of the market and increase the value of my annuity, therefore increase monthly payment amount? Thank you.

  8. Hersh Stern:
    Mar 31, 2015 at 09:43 AM

    Hi Linda-

    That would be a great idea. Unfortunately, none of the DIA manufacturers offer an indexed DIA option. There are fixed index annuities and hybrid annuities which allow you to delay income payments for years. Also, there are variable annuities which permit you to invest in stock and bond indices. If you’d like further help with a DIA, call me at 800-872-6684. Take care.

    -Hersh

  9. Skye:
    Apr 20, 2015 at 01:52 PM

    Can a DIA be purchased for my Grandchildren? I am considering spending $20,000 and my granddaughter is 19.

  10. Hersh Stern:
    Apr 20, 2015 at 01:54 PM

    Hi Skye-

    Yes, some of the insurance companies we represent issue DIAs to 19 year olds.

    If you'd like to receive a spreadsheet with DIA quotes from these companies for you to review you can use our calculator which you can find at the top of this page.

    Hersh

  11. Jeffrey:
    May 11, 2015 at 02:37 PM

    Are these annuities protected against future inflation?

  12. Hersh Stern:
    May 11, 2015 at 02:38 PM

    Hi Jeffrey-

    You can add a Cost of Living Adjustment (COLA) to a deferred income annuity.

    You can read a lot more about COLA riders here:

    https://www.immediateannuities.com/immediate-annuities/annuities-and-cost-of-living-adjustments.html

    Hersh

  13. Dave:
    May 12, 2015 at 02:37 PM

    I am 51 years old. I have after-tax savings that I want to invest in an annuity today and begin receiving monthly distributions from that annuity in 5 years. If I begin withdrawals at age 56 will I be subject to the 10% pre-age-59-1/2 penalty?

  14. Hersh Stern:
    May 12, 2015 at 02:38 PM

    Hi Dave-

    The 10% federal tax penalty will NOT apply if you bought a deferred income annuity (“DIA” aka longevity annuity) which began making payments at age 56 over yours (and a spouse’s) lifetime(s). However, if you set up a DIA to begin payments at age 56 for just a limited number of years (for example, only for a 10 or 15 year payout) then the interest portion of your payments is subject to the 10% penalty.

    Additionally, if you bought a multiyear guaranty deferred annuity (aka SPDA) or a fixed index annuity (aka FIA) today and removed the gains (interest) at age 56, you’d be subject to the 10% federal tax penalty. The length of the penalty period would be from ages 56 to 59-1/2. You could avoid the penalty if you annuitized your SPDA OR FIA contracts at age 56 for your lifetime (but not if only for a certain period of years).

    Hersh