4 Things to Consider Before Buying a Deferred Income Annuity: FINRA

Deferred income annuities, also referred to as longevity insurance, are often purchased as an alternative to a pension by those seeking a set amount of guaranteed income in their later years, the Financial Industry Regulatory Authority explains in a new notice.

But investors should do their homework before buying DIAs.

The products are typically sold by investment professionals or insurance agents, and should not be confused with deferred fixed income annuities, FINRA states.

“Think of DIAs as immediate annuities with a delayed payout phase. In both cases, you hand over a sum of money to an insurance company in exchange for a fixed payout for the rest of your life,” FINRA explains.

Unlike immediate annuities, however, the payout from deferred income annuities comes at a predetermined future date.

“DIA purchasers can also make additional contributions along the way, though insurance companies might impose limitations on additional contributions,” FINRA states.

“The upside of waiting: Payouts from deferred income annuities are generally larger than what one would get with an immediate annuity, albeit generally for a shorter length of time. One reason for these larger payouts is that some people who purchase these types of annuities will pass away sooner than expected,” FINRA said.

In the absence of a rider providing otherwise, “the excess premiums that individual paid don’t go to the individual’s heirs. Rather, the leftover payments, called ‘mortality credits,’ remain in the ‘mortality pool’ and increase the pot for individuals with longer life spans. At the same time, the deferral period allows insurance companies to invest the premiums at a higher rate of return,” according to FINRA.

Another way to buy deferred income annuities is through 401(k) and IRA accounts.

An individual is allowed to take a portion of a 401(k) or traditional IRA and use it to buy a qualified longevity annuity contract, or QLAC, FINRA explains.

“The value of the QLAC is excluded from the retirement account balance used to determine required minimum distributions (RMDs) that must be taken when a person reaches age 72,” FINRA states.

IRS rules allow investors to use a portion of funds from qualified retirement accounts (up to a limit adjusted by the IRS each year) to purchase a QLAC without it counting as a currently taxable withdrawal.

“You can delay RMDs for funds used to purchase a QLAC up to age 85, and you won’t start paying taxes on the money until you start receiving payments from your annuity,” FINRA states.

Here are four other things to consider, according to FINRA, when thinking about buying a DIA:

• Purchasing a DIA is generally an irrevocable decision. A person is trading liquidity — easy access to their cash — for the promise of a payout in the future.=
• Heirs could be out of luck. Most DIAs don’t pay heirs if the investor dies before reaching the age when they would have received benefits. A rider allows heirs to receive a death benefit, but the trade-off is lower payments.
• Don’t forget inflation. Generally speaking, payments from DIAs are not adjusted for inflation, meaning that the value of the payout could be eroded over time. An inflation protection rider can be purchased but will reduce payments.
• The guarantee of future payments is only as good as the insurance company backing them. Investors in annuities are protected by state guaranty funds if the issuer of the annuity fails, but the guaranty may not cover the full loss. Look into the guarantee in your state, and investigate the financial stability of the insurance company backing the contract before making this irrevocable purchase. Companies such as Standard & Poor’s provide ratings of insurance companies.