Understanding Deferred Income Annuities (DIAs): What They Are and When to Use Them
A deferred income annuity (DIA) is an insurance contract where you make a lump sum payment (or series of payments) and begin receiving guaranteed income at a future date that you choose, often years down the road. This allows your money more time to grow before income starts, making payouts larger when they begin. Clients can also select from several beneficiary options, ensuring that if you pass away before or after income starts, loved ones may still receive benefits.
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Planning for retirement today means more than just saving enough money. It means ensuring your money lasts as long as you do. One way to create a predictable income stream later in life is through a financial product called a Deferred Income Annuity, or DIA (pronounced Dee Yuh). While not as well-known as traditional pensions or 401(k)s, DIAs are growing in popularity because of their unique ability to provide guaranteed lifetime income starting at a future date that you choose.
A Deferred Income Annuity is a contract between you and an insurance company. You agree to pay a lump sum in exchange for a stream of guaranteed payments that begin at a specified future date, typically at retirement. The longer you wait before starting payments, the larger those payments will become. Payments to you can be scheduled on a monthly, quarterly or annual basis.
Unlike immediate annuities, which begin paying out income right away, DIAs allow you to defer payments. The longer you defer, the larger the lifetime payment will be.
DIA’s are designed to combat longevity risk or the possibility of outliving your money. Since income is guaranteed for life, the annuity will provide you with an income stream no matter how long you live. Once you purchase a DIA the term is locked in, and you don’t have to worry about the stock market. Your payment will start on the future date you have selected regardless of market conditions.
You can use either qualified or non qualified funds to purchase a DIA. That means you can use funds from your 401k or other IRS qualified retirement plan, or you can use nonqualified funds from your savings or checking account. If you use funds from a 401K or IRA the payments will all be considered taxable income. If you use a Roth IRA the payments will not be taxable. If you use non qualified funds from your checking account, a portion of your monthly check will be taxable, and you can set it up to have the annuity company send a portion of your monthly payment to the IRS or you can wait and pay the IRS yourself.
A DIA has a few best-case uses. The most common best-case use is for longevity insurance acting as a safety net in case you live longer than expected. For example, someone retiring at age 65 might buy a DIA that starts paying at 80. This gives them 15 years to draw from other retirement savings, knowing that a second stream of income will kick in later to cover living expenses and inflation risk.
This strategy allows retirees to spend more confidently in early retirement without fear of running out of money in their 80s or 90s.
DIAs are particularly attractive to healthy individuals with long life expectancies or a family history of longevity.
Let’s say you plan to retire at 65, but you won’t start collecting Social Security until age 70 to maximize your benefit. You may want a DIA to start payments at 70 to supplement your Social Security and provide a steady income from that point on.
Alternatively, if your pension ends or reduces at a certain age (say after a spouse’s death), a DIA can be used to cover that income when it is gone.
If you are concerned about inflation, a DIA can be one rung of a retirement income ladder to ensure your spending power does not erode over time. For example, you might buy an immediate annuity to start now, and a DIA to start in seven or ten years from now. This gives you two guaranteed income streams. One for early retirement and one for later, reducing inflationary concerns or reliance on the market and sequence-of-returns risk.
Things to Consider Before Buying a DIA
While DIAs have significant advantages, they are not ideal for everyone. Here are some important considerations:
Illiquidity
Once you buy a DIA, your money is locked in. You can’t access the principal if you change your mind, unless the contract includes a return-of-premium rider. Most annuity companies will not allow you to use more than 50% of your investable assets to purchase annuities so that you have the liquidity you need.
Inflation Risk
The value of your payments may decrease over time due to rising prices so it is important to have a additional funds to address future inflation concerns.
Timing Matters
Buying too early may not be optimal if your financial situation changes. A DIA purchased at age 50 may not be as efficient as one bought closer to retirement age.
Final Considerations: Who Should Consider a Deferred Income Annuity?
A Deferred Income Annuity is ideal for people who close to retirement with a reasonably long-life expectancy and want to guarantee income later in life. It should be used as part of a broader retirement income plan that includes Social Security, investments, and other fixed assets.
Think of a DIA like planting a fruit tree. You won’t see the results right away, but when you do, it will continue producing for the rest of your life.
If you’re someone who values predictability, peace of mind, and income security in your 70s, 80s, and beyond, a DIA might be a wise addition to your retirement strategy. As always, working with a fiduciary or trusted retirement advisor can help determine if it fits your unique goals.