The lowly deferred-income annuity is finally getting its moment in the sun, as well as in clients' retirement income plans.
Deferred-income annuities started as a variation of the single-premium immediate annuity (SPIA), using a similar concept: A client puts down a lump sum and receives a stream of income in return. With the deferred-income annuity, however, clients' income stream begins later in retirement — as late as their 80s.
There's no denying DIAs' run-up over recent years. In 2011, they posted $211 million in sales, according to data from LIMRA and the Insured Retirement Institute. That number had risen to $2.2 billion by 2013, and Joe Montminy, assistant vice president of the LIMRA Secure Retirement Institute, estimated it would hit $2.7 billion to $2.8 billion for last year.
These annuities also won more legitimacy in 2014 as academics and lawmakers embraced them. The Treasury Department produced guidelines for the use of qualified plan dollars within deferred-income annuities, thus creating the qualified longevity annuity contract. QLACs are exempt from required minimum distributions, so clients can wait beyond 70.5 to begin taking income from them. And last fall, in another piece of guidance, the Treasury outlined how DIAs can work within target date funds.
Nevertheless, DIA sales are a drop in the bucket compared with the size of the variable annuity market, which totaled $105.9 billion during the first nine months of 2014, according to LIMRA. To catch up, DIAs must capture broader interest and acceptance among advisers, particularly those at wirehouses and broker-dealers.
The industry's rapid growth can be attributed to more products from more participants, including QLAC manufacturers Principal Financial Group and American International Group Inc., according to Mr. Montminy.
Three insurers — New York Life, Mass-Mutual and Northwestern Mutual — were responsible for the lion's share of sales in 2011, he said.
Today, the market consists of 16 products and 13 manufacturers, according to Frank O'Connor, vice president of research and outreach at the Insured Retirement Institute.
Another driver of DIAs' growing popularity: Early versions were unappealing because clients turned over their cash and got nothing in return if they died before receiving income. Today's newest products come with optional death benefits and payment increases to protect against inflation.
“It's incorporating flexibility,” Mr. O'Connor said. “There are limited provisions to change the income start date, death benefits incorporated into the products, and it makes it more palatable.”
The DIA's income stream is attractive because clients can take advantage of mortality credits: Not all purchasers in a given pool will live long enough to receive income, and those who make it to an advanced age are subsidized by those who don't. The longer you defer the income, the larger the payout.
Though many in the industry envision DIAs as income sources for much older clients, the reality is that many tend to be in their mid-50s when they buy the contract; they begin receiving income when they reach 65.
That's the core market for MassMutual's DIA offerings, said Philip Michalowski, the firm's vice president of annuity product marketing.
“There's a lot of flexibility and use beyond that, but that's where the market is naturally gravitating,” Mr. Michalowski said.
Carrie Turcotte, president and senior financial consultant at Crest Financial Strategies, uses DIAs as additional income that clients can tap later in retirement. It acts as a dual-purpose backstop, in a sense.
“We like having layers,” said Ms. Turcotte, referring to clients of hers who are married and considering a DIA as part of a retirement income plan. “At first there's some deferred compensation from work, then Social Security, and a few years later, the DIA would kick in to either offset regular income needs or for long-term care,” she added.
Income from a DIA won't necessarily fund all long-term care needs, Ms. Turcotte said, but it can provide $1,600 to $1,800 a month toward the cost of care. The clients buying the product are in their mid-50s, and the adviser suggested they wait until 75 or 80 to begin receiving income. The product is a win-win: Someone is likely to use it for income or to supplement LTC needs.
The DIA makes sense because the wife has a family history of longevity, Ms. Turcotte said. The stream of income from a DIA could be put to a multitude of uses in the event long-term care isn't an issue when income begins.
Another way to work in DIAs is by using them alongside an investment-only variable annuity without living benefit features, as an alternative to a VA with a guaranteed living benefit feature, Mr. Montminy said.
But be aware of the trade-offs: Variable annuities with guaranteed withdrawal benefits let clients retain control of the asset — they can take withdrawals without annuitizing and turn off income — and that flexibility costs money. With a DIA, clients are giving up that flexibility and getting a better payout.
“Different consumers will have different needs,” Mr. Montminy said. “Some will want to retain their money, while others will want to retain control.”
DIAs have received some love from the research side.
Wade Pfau, professor of retirement income at The American College, has written that a strategy using TIPS and DIAs can help support a 4.17% withdrawal rate in retirement for clients with concerns about the market.
Meanwhile, David Blanchett, head of retirement research at Morningstar Investment Management, wrote a paper in October on using DIAs within the framework of a defined-contribution plan and as a component of target date funds.
In his research, Mr. Blanchett concluded that the average optimal allocation to deferred-income annuities was 30.52% of the investor's total portfolio at retirement.
The Treasury and Labor departments have paved the way for wider use of DIAs with target date funds in 401(k) plans, but it will take some more time for plan sponsors and manufacturers to get comfortable with them in that context. Similarly, advisers are waiting for the available market of DIAs and QLACs to open up. Plus, they have to convince clients they need these products.
“It's a harder sale to get people to understand that when they're 80, they'll get the money,” said Bernie Gacona, senior vice president and director of annuities at Wells Fargo Advisors. “Many people are saying they need that money at 65.”