July 26, 2013
Should You Buy Retirement Income?
Insurers Are Marketing 'Deferred-Income Annuities' to Baby Boomers
Hungry for Pensions. They Might Be Able to Do Better on Their Own
By ANNE TERGESEN
More insurers are marketing a relatively new breed of annuity to baby boomers hungry for retirement income. But potential buyers might be able to build as good a stream of income—or better—on their own.
The policies are called "deferred-income annuities." They allow buyers to convert a lump sum into a pension-like series of payouts for life. In contrast to an "immediate" annuity, which starts issuing checks almost instantaneously, a deferred annuity requires owners to pick a start date for payments—typically from 13 months to 40 years or even longer in the future.
Originally, deferred annuities were designed to prevent retirees in their 60s and 70s, who typically picked a start date in their 80s, from running out of money in later life. But in 2011, New York Life Insurance started marketing deferred annuities to people in their 50s, some 80% of whom lack a pension.
The pitch: Buy a deferred annuity in, say, your early 50s, and begin monthly payouts—your "pension"—when you retire.
About 10 insurers—including, this year, Guardian Life Insurance Co. of America, Principal Financial Group and American General Life Insurance—have introduced their own deferred annuities. Eight other insurers are developing products, according to Limra, a Windsor, Conn., research organization that specializes in insurance and retirement research.
Demand is strong. While sales of nearly every other category of annuity declined in the first quarter, investors poured almost $400 million into deferred-income annuities, up 147% from the same period in 2012, according to Limra.
"The annuity market in general hasn't done well since the 2008 market crash," says Jafor Iqbal, associate managing director at Limra. "Deferred-income annuities have been a recent bright spot."
For investors, the advantage of a deferred annuity is that preretirees can use a smaller fraction of their savings to lock in an income than they could with an immediate annuity.
For example, a 55-year-old man who wants an income of $17,000 a year starting at age 65 can put $150,000 into a deferred-income annuity. To get that same $17,000 a year with an immediate annuity, a 65-year-old would have to spend $260,000, according to New York Life.
So who should get a deferred annuity?
If Social Security plus any pension you are likely to receive won't cover your projected budget in retirement, David Babbel, a professor emeritus at the University of Pennsylvania's Wharton School, recommends buying one to bridge the gap. Such coverage could be especially critical for those who think that they or a spouse might live longer than average, he says.
If you take the plunge, it is important to recognize that annuity payouts, which are tied to interest rates, are near multiyear lows. So buyers should spread their purchases over time. That way, if interest rates rise, so will the payments received from future purchases.
Moreover, if inflation heats up, fixed annuity payments will lose some of their purchasing power. To protect against this, most insurers allow policyholders to raise their annual payouts by 1% to 3% a year or more.
Principal Financial and American General adjust payments to keep pace with the consumer-price index, and Northwestern Mutual Life Insurance gives policyholders a "raise" if it issues an annual dividend. (Note: Individuals selecting any of these features start with lower payments.) But there are downsides to deferred-income annuities.
As with other insurance products, they subject policyholders to the risk of an insurer's
insolvency. To protect your annuity investment, it is safest to stick with carriers with triple-A or double-A ratings of claims-paying ability.
It also is a good idea to divide your purchases among companies to stay below the projected benefit amount your state industry-backed guaranty association will cover in the event of an insurer's insolvency. (Go to www.nolhga.com to find your state's limit.)
In addition, as with most fixed annuities, you must surrender your principal to the insurer, which keeps the balance when you die. To ensure any remainder goes to heirs, most buyers elect to take a death benefit. But adding such a feature can reduce payouts by as much as 10%, leading
policyholders to sacrifice much of the annuity's advantage.
In that case, they might be better off simply buying bonds, says Moshe Milevsky, an associate professor at the Schulich School of Business at York University in Toronto.
Some advisers question the value of buying a fixed annuity before retirement for all but the most risk-averse investors.
Jason Scott, director of the Retiree Research Center at Financial Engines, a Sunnyvale, Calif., company that manages 401(k) accounts, says people would be better off investing in an
exchange-traded fund or mutual fund and buying an immediate annuity in retirement, when they can better judge their longevity and income needs.
Purchasing a Pension
Sales of deferred-income annuities by financial advisers and insurance agents have soared since 2010. Here's how they work.
• Deferal Periods: Insurers typically allow policyholders to defer taking income for a period between 13 months and 40 or more years. After you buy, you might have some flexibility to change the income start date.
• Income Start Age: Most insurers allow you to start taking income at any point up to age 85, although some permit deferrals to 90 or 95. The exact age at which you must start taking income will depend in part on whether you buy a contract with tax-deferred money.
• Minimum Premiums: Initial premiums typically range from $2,500 to $20,000, with some contracts allowing policyholders to add money in increments as small as $100 a month.
• Cost-of-Living Increases: Some contracts allow you to elect annual payment increases of up to 6.5%. Others adjust payments to keep pace with the consumer-price index.
• Withdrawals: Some carriers let policyholders accelerate up to six months of payments.