The blog post two weeks ago, Using Fixed Income Annuities to Build Your Income Portfolio Ladder, introduced a powerful income laddering strategy using a customized blend of two types of fixed income annuities to create and optimize retirement income. The purpose of the strategy bears repeating since it is the catalyst for this week’s blog. As discussed two weeks ago, this strategy offers retirees the benefit of predictable inflation-adjusted income streams to close projected income gaps as well as generate tax efficiency for the nonretirement portion of one’s portfolio while reducing exposure to the gyrations of the stock market.
The two types of fixed income annuities that are used to implement this strategy are immediate and deferred. Immediate income annuities, or “SPIAs” (the acronym for single premium immediate annuities) was the subject of last week’s blog. I encourage you to read this post if you haven’t done so already. It discussed the unique characteristics and benefits of SPIAs that often position them as the cornerstone of retirement income plans. This week’s blog focuses on the second type of fixed income annuity that is used to create and optimize retirement income – deferred income annuities, or “DIAs.”
As noted in Using Fixed Income Annuities to Build Your Income Portfolio Ladder, while the use of SPIAs is widespread, deferred income annuities, or “DIAs,” are currently offered by only a handful of life insurance companies. These include Hartford Life, Prudential, and Symetra Life Insurance Company.
DIAs are similar to SPIAs since they both pay periodic income for a specified period of time or over one’s lifetime or joint lifetimes as applicable. Unlike SPIAs, however, the start date of the payments for DIAs is deferred for at least 13 months from the date of investment. Whereas SPIAs may be viewed as the steak in a retirement income plan, DIAs are the sizzle.
Why use DIAs in a retirement income plan? As illustrated in Immediate Income Annuities: The Cornerstone of a Successful Retirement Income Plan, an individual SPIA can solve many income needs due to its many unique characteristics and benefits. As pointed out in Is Your Income Portfolio Plan Laddered?, our financial situation and needs will change at different stages of our retirement years. As a result, the primary goal of an income plan should be to generate different and distinct income streams to match our expense needs associated with each stage while also funding periodic one-time needs.
Given this reality, the income from a single investment that makes a fixed payment beginning one month after purchase for either a fixed number of years or for the remainder of one’s life, i.e., a SPIA, while it may, in combination with other income sources, match one’s income needs for the first several years of retirement, generally will not, in and of itself, accomplish this result for the entire duration of most individuals’ retirement. Recognizing this fact, the life insurance industry developed a solution that has all of the wonderful benefits that retirees seek from SPIAs with one big difference: a delayed start date.
As an example of the use of DIAs in a retirement income plan, suppose that you are about to retire, your monthly income need is $6,000, with $2,000 covered by Social Security, and the other $4,000 met by withdrawals from an IRA. The problem is that the value of your IRA account is projected to enable you to take your required monthly withdrawals of $4,000 for only ten years before it is depleted. In addition to your IRA, let’s assume that you also have a nonretirement brokerage account with a value of $700,000. Recognizing your predicament, you invest $500,000 from your brokerage account into one or more DIAs that will begin to pay you $4,000 per month plus an annual increase of 3% for twenty years beginning ten years from today.
In addition to solving a retirement income need that isn’t projected to begin until several years into retirement – ten years in the example – DIAs allow you to take advantage of another often-ignored financial planning strategy: time value of money. If you were to purchase the same income annuity as the one in the example, with a monthly payout of $4,000 with an annual increase of 3% and a twenty-year payout that begins one month from today instead of ten years from today, i.e., a SPIA, in addition to not matching your income needs, you may be required to invest an additional $150,000, or $650,000 from your $700,000 brokerage account.
DIAs are the sizzle in a retirement income plan since you can combine them with SPIAs to design a customized retirement income plan that will enable you to enjoy predictable inflation-adjusted monthly income that, in combination with other source of income, e.g., Social Security, dovetails with your projected income needs for the duration of your retirement while minimizing or eliminating the risks associated with investment in the stock market. I would venture to say that most retirees would be very satisfied with this solution.