Deferred Income Annuities: Latest Research on Benefits, Laws

Retirees are weathering retirement under “substantial risk and uncertainty” by not choosing a deferred income annuity, a product “that specifically targets longevity risk” and is much loved by economists, according to retirement experts. In their Brookings Institution report — “Can Annuities Become a Bigger Contributor to Retirement Security?” — Martin Baily and Benjamin Harris write that despite the benefits, the use of deferred income annuities “has seen close to zero take-up in recent years.”

Academic research on annuities has analyzed the benefits of deferred income annuities, the paper states. Such a policy could be purchased at the date of retirement, or earlier by making contributions to a policy during working life.

A deferred income annuity policy pays nothing until the person reaches old age, say 80 or 85 years, at which point it pays a fixed amount each month or quarter. Someone in their 60s or 70s can then plan their expenditures, knowing that if they live into their 80s or 90s they will be covered financially by the payout from their annuity policy plus their continuing Social Security benefits, the paper explains.

“Economists have shown that under a range of assumptions about people’s attitudes to risk, a deferred income annuity policy makes people better off,” the paper states. In economic models, “People are made better off because deferred annuities offer an opportunity to purchase insurance against longevity risk cheaply — allowing retirees to keep much of their portfolio of assets intact for other purposes.”

Deferred income annuities are “cheaper” than immediate income annuities, the paper asserts, “in that the stipend they provide is high relative to the amount they cost for two reasons.” First, the annuity company can earn a return on the premium paid for many years before they start paying out benefits.

Second, “a fraction of those that buy deferred annuities will die before their annuity pays out, so their premiums go to support those that live into their 90s,” the authors state. “This is the same as homeowners insurance where those whose houses do not burn down subsidize those whose houses do burn down. Despite their obvious value, almost no one buys deferred annuities in practice.”

Baily and Harris also note that the Setting Every Community up for Retirement Enhancement (Secure) Act, which is tied up in the Senate, seeks to shield employers from fiduciary liability in choosing an annuity. The Secure Act attempts “to get more annuities into workplace plans by making it easier for employers to protect themselves from future liability,” the authors write.

Both the Retirement Enhancement Savings Act (RESA) and the Secure Act “contain safe harbor provisions developed largely by the insurance industry to protect employers from potential fiduciary liability for their selection of annuity providers. As fiduciaries, employers are still expected to undertake an objective, thorough, and analytical search for annuity providers, but the legislative safe harbor provisions are intended to simplify and clarify this process, making it much more explicit, objective, and attainable,” the paper states.

Under this safe harbor, “employers would not be responsible if the annuity provider enters insolvency as long as they have followed a reasonable path when choosing the provider,” the authors explain. “If concern over liability is indeed a major obstacle towards employer take-up of annuities, this legislation should lead to a rise in annuity offerings.”