Are DIAs Better Than SPIAs – Maybe Not?
Deferred-income annuities (DIAs) have been receiving favorable press based on claims that they generate greater retirement income than traditional single-premium immediate annuities (SPIAs). DIAs have also been promoted by the Treasury Department, which has introduced new rules to facilitate their use. But I’ll present a contrarian view and demonstrate that retirement strategies built on SPIAs can outperform those that utilize DIAs.
DIAs have become a hot topic among advisors and researchers. Google searches on DIAs produce about 10 times as many hits as searches on SPIAs. The numerous articles and papers about DIAs are overwhelmingly favorable, while SPIAs receive mixed reviews. DIA sales of $2.7 billion for 2015 still lag SPIA sales of $9 billion, but have been growing faster.
My view on DIAs is a minority one, but I hold it for good reasons.
A year ago, in an Advisor Perspectives article, I compared DIAs to a variety of rival products, including SPIAs, and concluded that no offering is one-size-fits-all and different products will best fit particular client needs. Here I’ll focus on particular situations that have been recommended for DIA use and demonstrate how alternative strategies utilizing SPIAs may actually work better.
DIAs can be used in two quite different ways to provide secure retirement income. The product can be used in the pre-retirement “red zone” when savings accumulations are particularly vulnerable to poor market performance. For example, a 55-year-old could purchase a DIA that will pay a specified lifetime income beginning at age 65. This would provide secure lifetime income insulated from stock market fluctuations prior to retirement. In 2014 the Treasury Department encouraged this approach by introducing new rules to allow 401(k) plan sponsors to include DIAs in target-date funds.
A second use of the product is to provide longevity insurance. An example would be a 65-year-old who purchases a DIA that pays lifetime income beginning at age 85 (a 20-year deferral period). This way, the retiree doesn’t have to worry about making savings last for an unknown future lifetime, but instead can focus on making savings last 20 years. In separate 2014 guidelines, Treasury named a new product class, qualified longevity annuity contracts (QLACs), which provide an exemption from the required minimum distribution (RMD) rule that withdrawals from tax-deferred accounts must begin at age 70.5.
There have been a number of different names assigned to this second version – longevity insurance, deeply deferred annuity, advanced-life deferred annuity (ALDA), and now the Treasury designation of QLAC. For the remainder of this article I’ll refer to the pre-retirement use as DIA and the late-in-life longevity version as QLAC.
DIA versus SPIA comparison
This comparison will be based on a 55-year-old female who wishes to dedicate $500,000 of an IRA or 401(k) to generate secure lifetime income beginning at age 65. Let’s look at two strategies she can use:
- Use the $500,000 to purchase a DIA that will provide level annual payments beginning in 10 years. Based on rates from CANNEX, a pricing information service, the annual payout would be $44,011 based on an average of the highest three companies. This particular DIA structure would refund the $500,000 premium if the purchaser died before age 65.
- At age 55, dedicate $500,000 to either a long-term bond fund or a structured portfolio of long-term bonds with maturities ranging from 10 to 35 years (if available). At age 65, sell the bond investments and use the proceeds to buy a SPIA.