Purchasing a deferred annuity can be an effective way to protect against retirement “longevity risk”—that’s the possibility of running out of savings over a lengthy life in retirement. That’s according to a study by the Employee Benefit Research Institute.
In addition, Fed Week’s recent article, “Deferred Annuities Can Protect against ‘Longevity Risk,’ Study Says” that the prospect of outliving retirement savings is a very real concern for many Baby Boomers and Gen Xers.
However, just a very small percentage of defined contribution and individual retirement account balances are annuitized. The Employee Benefit Research Institute report notes that a significant percentage of defined benefit accruals have been taken as lump-sum distributions, when the option was available.
A deferred annuity is a kind of annuity contract that delays income—which is paid out either in installments or a lump-sum payment—until the investor chooses to receive them.
This type of annuity has two main phases: (i) the savings phase, when you invest money into the account; and (ii) the income phase, when the plan is converted into an annuity and starts to pay out to the account owner. A deferred annuity can be variable or fixed.
A deferred annuity works like it sounds, it is deferred or delayed. Instead of an immediate payout beginning at retirement, the payout starts much later, such as 20 years after the purchase.
The report said that many people can be hesitant to buy these annuities, because they’re giving up control of part of their retirement savings for a long period. However, the Employee Benefit Research Institute report emphasized that due to the delay in the payout, deferred annuities can cost much less than those annuities designed to pay out immediately.
Based on an analysis involving four age groups, the study found that purchases using less than 20% of retirement savings improved the retirement finances after payouts begin for each, versus keeping them in IRAs or other retirement savings vehicles during that time.
That wasn’t necessarily true of using larger percentages, the research noted, because of factors like the higher potential for needing to finance long-term care, before the annuity would begin payouts.
Reference: Fed Week (April 17, 2019) “Deferred Annuities Can Protect against ‘Longevity Risk,’ Study Says”