My review beginning on p. 38 of deferred income annuities (DIAs) (products that delay the start date of annuitization by more than the 12-month time limitation imposed on single premium immediate annuities) provides a generally positive assessment of this recent entrant to the annuity marketplace.
There are good reasons for optimism. As the advisors and experts I interviewed in the feature point out, the products offer the ability to lock in a guaranteed future income stream years in advance of annuitization. And many among the current crop of products offer options—life contingent versus period certain payouts, single premium versus multi-premiums, a return of death benefit or living commuted value—that provide clients with a degree of flexibility not available in earlier iterations.
True, many of these benefits are available in other types of annuities. What really distinguishes the DIA is the product’s internal rate of return (IRR): the rate at which future payments are discounted to equate them to a present value (in this case, the annuity’s purchase price).
As sources point out in the feature, the IRR can be quite high (depending on the period of deferral) because of the accumulating mortality credits. Add to this the DIA’s tax-favored treatment—distributions are a blend of taxable gains and non-taxable basis—and the product might seem an easy sale.
Yet, advisors and consumers have to weigh these benefits against the potential cons. Chief among them: the loss of liquidity that policyholders give up in exchange for the mortality credits they can rack up over a 10-, 20- or 30-year deferral period. Keeping the funds in a liquid cash account may be the more prudent course for clients whose financial situation in (or leading up to) retirement is sufficiently uncertain.
Also to be considered is the opportunity cost resulting from the loss of liquidity. Daniel Flanscha, president of Long Peak Financial LLC, Loveland, Colo., and an adjunct professor for the Graduate Tax Program at the University of Denver, says advisors need to determine whether clients can achieve a higher IRR using an alternative (and more liquid) investment strategy.
Flanscha pegs the DIA’s IRR at between at 4.5% and 5.8% during the accumulation or deferral phase. In the current low interest rate environment, the higher of the two IRRs, Flanscha acknowledges, may be hard to match. But assuming that 4.5% is the more realistic of the two, then the client may be better off investing in, say, taxable bonds, CDs or mutual funds, then rolling the retirement funds into a SPIA (which enjoys a higher exclusion ratio—the ratio of non-taxable to taxable income—than the DIA).
Additionally, should the client elect an optional rider, such as a death benefit or return of premium, then the power of the DIA’s accumulated mortality credits is diluted. These riders provide, in effect, an indirect way of purchasing life insurance. If providing a legacy for heirs is desired, then the smarter choice is to dispense with the annuity’s death benefit and buy life insurance. As Flanscha observes, a life policy can provide significantly more leverage for the premium dollars invested.
Numbers aside, one might reasonably question whether DIA backers are justified in their optimism about future sales. True, both New York Life and Thrive Income are, as I note in the feature, enjoying enviable revenue streams from the product. But these companies are, to my understanding, marketing DIAs, and funding agent educational initiatives about the products, unmatched by other providers.
Indeed, I was astonished to learn from John Olsen, a chartered financial consultant and president of Kirkwood, Mo.-based Olsen Financial Group, that he regularly encounters during speaking engagements agents who know little or nothing about their carriers’ DIA offerings. And, Olsen insists, the carriers are to blame for their agents’ ignorance because the companies are doing a “terrible job” promoting the products.
What might also dampen sales is a continuing hesitancy among non-DIA providers to join the fray. Rao Garuda, a principal of First Financial Resources, Columbus, Ohio, says that carriers interested in entering the market need substantial capital reserves to design, market and support the products. All but the largest insurers, he suggests, lack the deep the pockets to be players in the DIA space.
Perhaps. But I suspect that providers still on the fence, and the less than aggressive insurers that have DIAs, will reconsider their market posture as more of the millions of boomers now entering retirement buy into the solutions. For me, thus, the central question is not whether DIAs will achieve wide market acceptance, but how soon.