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Deferred annuities (also referred to as DIAs or longevity annuities) are an insurance contract. When in a qualified plan such as a 401k or IRA, this type of annuity is known as a QLAC (qualified longevity annuity contract) with different applicable rules. In this article. 5 financial experts discuss important things to know about deferred annuities.
Charges And Fees, The Seller And Salesperson Matter
“A deferred annuity is a long-term savings plan with an insurance company that allows you to defer any payments to the annuity for an unspecified period of time. Any incomes earned from investing the deposits from a deferred annuity account also has its tax-deferred up to the time of withdrawal. The primary difference between the differed and immediate annuities lies in the access to incomes and interests earned from the utilization of the annuity. Where immediate annuities give you access to these funds as soon as possible while the deferred annuity has its repayment /withdrawal periods set for a future date. Before buying into
*Charges associated with the annuity: deferred annuities attract such charges as taxes, withdrawal and surrender fees, contract fee, transaction fee, premium tax, and premium tax. Ask your agent to lay down all the charges and fees associated with the contract before signing and go through the impact they have on your deposited amounts and investment incomes before signing the annuity contract.
*Benefits associated with the annuity: Explore the different types of annuities such as the life Only Annuity, Life Annuity, and Joint and Survivor annuity and the benefits of either. If you would like your annuity to pass on to your beneficiaries, you are better off with a Life annuity and if you are looking for retirement income as a couple, go for Joint and Survivor annuity that pays premiums to both parties.
*They are tax-deferred, not tax-free: You should also note that incomes derived from the annuity deposits are taxed at a later date (at the time of withdrawal or surrender). This type of tax is referred to as deferred income tax and is different from tax-free income that doesn’t attract any taxes.
*The seller and salesperson matter: Conduct background checks on both your preferred insurance company and their agents. Take into account such factors as their reputation and review other consumer’s experience with the insurer. If they have a free-look period, take advantage of this to go through the contract’s fine print and don’t hesitate to cancel the annuity should you find their terms too exploitative.”
Edith Muthoni, Chief Editor, Learnbonds.com
In Specific Situations, A DIA Could Provide Benefit To The Investor
“Deferred Income Annuities should rarely be used as there are generally investments that are much more advantageous to an investor's goals. However, in specific situations, a DIA could provide benefit to the investor. The most common type of DIA recommended is a QLAC (qualified longevity annuity contract). QLAC’s were approved by the Treasury Department and the IRS to use within qualified plans (401(k), 403(b), IRA (non-Roth) and non-governmental 457(b) plans). The purpose behind the regulation is to allow consumers to defer RMDs on a portion of their qualified money and provide longevity insurance at older ages. QLACs have strict rules that must be followed when properly investing in one.
- Premiums are limited to the lesser of $130,000 or 25% of the participants' qualified account values. Dollar limit applies across all plans. Percent limit applies to each plan separately and to IRAs on an aggregate basis.
- Payout options available
- Single or Joint Life Only
- Single or Joint Life with Cash Refund
- COLA options can be used
- Death Benefit = Return of premium (no additional interest is allowed under the regulation)
- Income must start the month after the participant turns 85 or sooner. Start date must be elected at issue. (All contracts allow up to a 5-year window to advance or defer the start date)”
Jordan Sester, Founder / Investment Advisor Rep, J.S Financial Group
A Somewhat Convoluted Investment Option
“Drawbacks and researching the pros and cons despite all the benefits outlined, a DA is still an annuity – a somewhat convoluted investment option. It doesn't suit everyone. There’s no free lunch when it comes to Das and IAs as structured investment channels. One should look into the taxes, penalties, surrender charges, and annuity management fees in your DA plan as the principal drawbacks. Compare and research these as being crucial. Annual charges of 1.25% and higher are possible. When considering a deferred annuity versus immediate annuities, or any other investment option for that matter, there's no getting away from the irrevocable step of consulting a wealth management professional.”
Gordon Polovin, finance expert, serves on the advisory board for Wealthy Living Today
A Deferred Annuity Is Not A Guaranteed Return, No-Risk Investment
“Deferred annuities are a powerful tool to help mitigate the risk of outliving your money. However, like every other product, it's not meant for everyone.
What every investor needs to know is that it's not a guaranteed return, no-risk investment. Many times it can be convincing know you'll have income for life later during retirement. However, it doesn't take into consideration the opportunity cost of investing your money elsewhere.
The further you are from retirement, the less it makes sense. You can often invest your money into a well-diversified portfolio that gives you a higher long-term return and gives more liquidity. This is greater emphasized when you consider inflation.
The problem is that people categorize deferred annuities as either good or bad. The reality is that it has its pros and cons, and you want to see if it makes sense for your situation.”
Nico Felipe, Financial Planner, Vantage Planning
Deferred Annuities Need To Be A Piece Of The Retirement Plan, Not The Entire Plan
“Deferred annuities can play a vital role in someone’s retirement plan. It needs to be a piece of the plan, not the entire plan. There are a few options with deferred annuities: variable, fixed, and indexed.
Variable annuities have all the upside of the market and all of the downside. This means the money in these products is at risk. For this reason, we do not recommend variable annuities in addition to their higher fees.
Fixed, or multi-year guaranteed annuities, offer a guaranteed rate of return for a specific period of time. These can range from 1% to over 3.5% depending on the company and the length of time someone is willing to commit their money to this kind of product. There is no risk and you know exactly what is going to happen to your money.
Indexed annuities offer upside potential with no market risk. When the market goes up, the account goes up. When the market goes down, the account stays level. The important thing to know about these annuities is that some products have caps [a maximum amount of interest you can earn] or participation rates. A cap means that if the market goes up 20% and you have a cap of 12%, then 12% is the maximum amount your account could ever earn. A participation rate can be 50%. Meaning if the index account earns 10%, your specific annuity will receive 5%.
Some advisors do not recommend annuities because some of them have low caps and low participation rates. However, there are annuities that have no caps and high participation rates, such as 80%, 100% or even higher.
The annuities we recommend, fixed and indexed annuities, give you protection with no risk. But you do give up liquidity. That is why you don’t need all your money in an annuity. You do need some money in the market, but an appropriate amount.
The other thing to consider is the surrender charges. Most people think of these as a negative but let me explain what they really mean. When you see a surrender value that is less than what you put into an annuity, that means you are accessing it earlier than intended and there are fees. Just like if you sold your house there would be fees associated with that, like for a realtor. If you sell stocks, there are generally fees with that.
The benefit of a surrender charge is that the insurance company can tell you exactly what your money will be worth in the future, regardless of what happens to the market. Investments in the stock market can’t do that. So surrender charges are not a bad thing. Think about it, would you ever take all the money out of your 401(k) at one time? No, that would be silly and would cause a huge tax issue. So you would not likely do that with an annuity.”
Cory Carlton, CEO & Co-Founder, BOTH HANDS Financial Group
Akin to any type of investment, deferred annuities can be a good option for some investors. If you are interested in deferred annuities, take into account what the experts in this article have discussed, consult a financial professional, and always do your due diligence.