Today's topic is deferred income annuity pros and cons. This is a big one because, with every annuity type, there are limitations and benefits, and I'm going to explain them to you so you can make an excellent decision whether a deferred income annuity fits you or not.
We're going to cover a lot today about deferred income annuities; we’re going to talk about a deferred income annuity? What does it solve for in your portfolio? We're going to talk about specific benefits and limitations. We're also going to discuss structuring choices, how you quote them, and where it fits in your portfolio.
So what is a deferred income annuity? In my world, it's an income later guarantee. You need income in the future, and a deferred income annuity can guarantee that payment amount at the future start date. Some people call it a longevity annuity. A lot of financial journalists talk about that. What's the longevity risk? It's solving for payments that you cannot outlive. That's what a deferred income annuity does. Remember, the income stream is contractually guaranteed. You can't outlive it, and you can structure with you and your beneficiary.
With deferred income annuities, income starts typically as soon as 13 months and as far out as 45 years. What does deferred income annuity solve for? It solves for income. It solves for pension income. When you think about social security, and you go, "Well, I'm 63, and I'm planning on turning on my social security at age 70." A lot of you are doing that because you get the higher payout because you're going to be older. The same principle with deferred income annuities. I need income to start later. The later it starts, the older I am, the higher the payment.
A deferred income annuity can combine with social security or whatever income streams you also have in place for that income floor. I call it the income floor, that guaranteed amount of income that's come into your bank account every month, that you know will be there, that it's not going to be affected by the market, and that you can never outlive. That's what deferred income annuity solves for. Let's talk about the pros and cons, benefits, and limitations.
The pros of a deferred income annuity are that it's contractual. Once you get that contract and once you see the guaranteed income amount on that page, you're going to get it. Regardless of what happens politically, economically, it doesn't matter; it’s contractual. You've transferred The risk to the annuity company to pay you at that specific time that you've chosen. Another pro is that, with most contracts that are not life only, you can change the start date one time after the policy has been issued, which is good. Life changes; things change. Maybe you need the income to start later than when you filled out the application; you can do that with deferred income annuities.
It does give you that flexibility. Also, a pro, it's customizable. You can set up anywhere you want. You also can set it up to what I call handcuff the beneficiaries to make sure that they don't show up at your funeral in a Ferrari that they paid cash for, that they're making payments because they will show up at your funeral in a Ferrari. Some other pros about deferred income annuities are they can be used in an IRA, a non-IRA, or Roth IRA. There are specific rules with a traditional IRA. Part of it, you can't defer it past 70.5, and we'll cover that in a future video. Those are the pros of a deferred income annuity.
Let's talk about the limitations of a deferred income annuity. They're rigid contracts; there’s no liquidity, they're irrevocable. Most of them don't have any type of liquidity provisions, and if they do, anytime an annuity company gives something away like that, they're charging for it. They have significant buildings for a reason; they have giant logos on the plane. They're not philanthropists. Deferred income annuity limitations come down to there's no market growth. In other words, there's opportunity loss.
“Stan, if I had to put it in the market, I would've done better.” That's an apples and oranges comparison. Deferred income annuities are contracts; they’re not an investment. You're transferring the risk so that the annuity company will pay you for the rest of your life at a specific time in the future. But the limitations are that it's a rigid contract, you're not getting any type of market growth, and also, there's no trackable interest rate during the deferral years. You're saying, well, that's crazy. Why would they do that? What they do, the annuity companies enhance the payout the longer you allow them to hold onto the money. I'm from the South, so the longer it cooks, the more you get. That's the limitations of a deferred income annuity.
Pros and cons of deferred income annuities, which outweighs the other? I'm not sure you can lean either way. There are arguments against the deferred income annuity; there are arguments for a deferred income annuity. It comes down to what you're trying to solve for. It comes down to the two questions, what do I want the money to do contractually, and when do I want those contractual guarantees to start? Understanding the limitations and benefits and weighing them both will allow you to make a good decision. Maybe the fact that there's no market growth or a very rigid contract means you don't buy one, that's fine, but you have to know both good and evil going in. There's no pound the table reason to buy it, or not to buy it, you just have to understand it in full.
I got a call the other day, and the gentleman said, "I'm not sure when I need income, but I know I'm going to need income in the future, and I want to plan for inflation." No annuity on the planet perfectly addresses inflation. Even though an agent will tell you that they have it, they don't. How do we go about doing it? This gentleman had $400,000; he said, "I want to plan for future income, but I don't know when I want to start that." Here's what we did. We split the purchase up.
We bought four contracts, 100,000 each, and we deferred them differently. He was 60 years old, so we had one started at age 67, one started at age 70, one started at age 72, and the other started at age 75. He structured it to change that, but now what does he have in place? He's laddered the deferred income annuity purchase for income to start at different increments, different years in the future. Forget inflation; he solved for it.
Let's talk about structuring choices with deferred income annuities. Once again, customizable. You just have to tell me what you're trying to achieve and who that person is if it's joint. I'm going to need dates of birth, because it's based on your life expectancy, not interest rates. The way the pricing is, is they're looking at life expectancy when you make the payment. Interest rates play a secondary role, and the income stream is a combination of return of principal plus interest. You can structure it in a myriad of ways. You can add the cost of living adjustment increases to the payment, which sounds fantastic on the surface. The catch is, if you add that, then the annuity company, because they have the significant buildings, are going to lower the payment.
If you're interested in an increase like a COLA, cost-of-living adjustment, have me quote both, have me show you how they price it in with and without. But understand that you can structure these things exactly how you want them to work. How do you even quote for an income annuity? First of all, you have to find someone like me representing all carriers. We're going to quote all carriers; I have no favorites. I'm going to go into the quote; we’re going to quote every single carrier based on the parameters you give me. It's like buying a plane ticket; I don't know who will finish first. Every 7-10 days, the quotes change like a gallon of milk.
The quoting process is, I quote all carriers, I send you the PDF of that quote, then you have to make a decision 7-10 days. There’s no urgency to buy an annuity ever; it’s a contract. But if you want that specific quote with that specific carrier, then you'd have to move on it and lock that quote in, but that's how you quote it. Tell me exactly what you want to solve for, whether it's a lump sum, how much does this lump sum solve for, contractually from a guaranteed payment standpoint, or, hey, Stan, we need this amount per month, how much would it take to create that?
Either or it's a commodity quote that will run through all carriers for you. You've got the pros and cons of these things. You got the pros and the benefits of deferred income annuities and the limitations and the cons of deferred income annuity, so where does it fit in your portfolio? It fits future income needs. If you don't need income in the future, guess what? You don't need a deferred income annuity. But if you do, and if you think you do, and if you want to solve for it for maybe you, or your spouse, or partner, then they might fit, and you might want to quote it.
Never forget to live in reality, not the dream, with annuities and contractual guarantees! You can use our calculators, get all six of my books for free, and most importantly book a call with me so we can discuss what works best for your specific situation.