How Can I Lock in a Future Income Stream With an Annuity?
Annuities Have Provided a Guarantee of Income for Centuries
Annuities can easily be traced back to the Roman times when soldiers and their families were promised pension type annuity payments for themselves and their families. Annuities were primarily put on the planet for income, and this was the only use for the product until 1952 when the first variable annuity was introduced. Then in 1995, the first indexed annuity was offered. At the end of the day, annuities are primarily used as income solutions, with annuities being the only product to guarantee income regardless of how long you live.
Two Primary Annuity Product Types
Income Later, or Target Date Income, can be delivered by longevity annuities (aka Deferred Income Annuities, or DIAs) and Income Riders attached to deferred annuities like a variable or indexed annuities.
Flexibility Is the Primary Difference
Income Riders are more flexible than Longevity Annuities. This means that you can start your income stream earlier or later than initially planned with Income Riders, but the flexibility comes with an annual fee for the life of the policy.
Longevity Annuities are more rigid from a contractual standpoint. They do not have any fees and the payouts can be higher than Income Riders, because of the simplicity with no moving parts. In addition, Longevity Annuities allow you to attach a COLA (Cost of Living Adjustment), which is an annual increase in the life of the policy.
In every income later or target date proposal, I always show both strategies, so that a true comparison can be made. Neither is better than the other, and it all comes down to the specific situation and the exact goals that need to be accomplished.
Longevity Annuities Are Now Allowed in 401ks & IRAs
In July of 2014, the Department of the Treasury in unison with the IRS approved the use of Longevity Annuities (aka Deferred Income Annuities, DIAs) within 401ks and IRAs. This is a really big deal and is so pro-consumer that I am shocked it was actually approved.
The current rules in place allow a Qualified Longevity Annuity Contract, or QLAC, purchase amount of 25% of your total 401k or IRA balance or $125,000, whichever is less. Longevity annuities allow you to defer for as short as 2 years, or as long as 45 years. This is a valuable and direct opportunity for younger workers who have a 401k in place, and an opportunity for those planning for income in the near future also.
Annuities Can Be Laddered to Provide Future Income
Income later or target date income planning does not have to utilize just one date in the future for the income stream to begin. Most people are familiar with laddering strategies using bonds or CDs, but the same timing strategy can be used with annuity income. Annuity laddering strategies can be adjusted to fit particular situations and income needs.
When you take income from an annuity, the contractually guaranteed payment is primarily a reflection of your life expectancy (or lives, if held joint with a spouse) at the time you turn on the annuity income stream.
You Can Transfer Your Longevity Risk to the Annuity Carrier
It is common sense that the older you are when you turn on the payments, the higher the income stream. Your life expectancy lessens yearly, and annuity payments are calculated using your life expectancy. In essence, you are placing a bet with the annuity company that you are going to live longer than they think you are going to live. If you do live past that life expectancy benchmark, then the annuity company is on the hook to pay you as long you live. That is the primary value proposition of an income annuity.
You transfer the risk of outliving your money to the annuity carrier which risks you living longer than expected.
Annuities Should Be Owned for What They Will Do, not What They Might Do
With future income planning, you can know to the penny what the payments will be at the desired date. Only annuities can offer this type of concrete planning, and a reason why one should consider the possibility of adding these types of risk transfer strategies to solve for any income needs.