It is widely known that a very small proportion of nonqualified deferred annuity contract owners–variable and fixed–ever choose to “annuitize” in order to receive a stream of payments for the rest of their lives. Some insiders put the annuitization at less than 5%. (See box for reasons.)
In recent years, life insurers have taken steps to encourage people to reap the benefits of deferred annuity life annuitization guarantees. For example, the products are more flexible, and post-annuitization liquidity and guarantees are becoming common. Also, substantial resources have gone into educating the public, policymakers and financial advisors about life annuity benefits (e.g., the work of Americans for Secure Retirement). Even so, progress is slow. One reason is that current tax rules make it hard for people to annuitize only a portion of a deferred annuity.
Consider three friends–Joan, Jill and Ann–who all are retiring from the same company at age 65. Each has $250,000 in a 401(k), $100,000 in mutual funds and $100,000 in a nonqualified deferred variable annuity–but no defined benefit plan. If the 401(k) is typical, it will not offer a lifetime annuity option, so their only source of “annuity” income will be monthly Social Security checks–which are likely not enough to cover their monthly expenses.
Each new retiree could benefit from an additional source of lifetime income. Their deferred VAs are ideal for that. Based on current purchase rates, the annuitized VAs could pay each $623/month for the rest of her life (or $609/month lifetime, with payments guaranteed for at least 10 years).
Joan may be reluctant to spend any of her nonemployer plan retirement savings on a life annuity, let alone half ($100,000), even with the 10-year guarantee. Assume, however, that Ann, who knows the benefits of a life annuity and is familiar with Joan’s finances, persuades Joan to obtain at least some additional lifetime income. Joan concludes she could spend 25% ($50,000) of her personal savings on a life annuity that pays about $300/month.
Jill, like Ann, appreciates the benefits of a life annuity and decides she only needs an additional $200/month (annuitizing one-third of her VA cash value).
Ann, meanwhile, needs an additional $300/month now and $300/month more starting in five years when she moves to a retirement community (annuitizing half her VA now and half in five years). This will likely result in over $600/month in income since Ann will be five years older at the second annuitization.