Longevity Annuities (DIAs)

An income annuity is a way to create a guaranteed stream of income for life. In many ways it functions like a personal pension. You provide a lump sum to an insurance company, and in return, it agrees to make regular income payments to you. A longevity annuity is a type of income annuity in which payments begin later, allowing the premium more time to grow before income starts.

Step 1: You pay a lump-sum amount (the premium).

Step 2: The insurance carrier guarantees a stream of regular income payments starting later, more than one year from now.

Step 3: Payments continue for a specified period or for the rest of your life.

If you are planning to purchase a longevity annuity using qualified retirement savings (such as a Traditional IRA or 401(k) rollover) and want income payments to begin after age 73 but before age 85, you may want to consider a Qualified Longevity Annuity Contract (QLAC). A QLAC is a specific type of deferred income annuity designed to meet these requirements.

The income offered on longevity annuities will vary over time as market conditions change, being driven most notably by longer-term Treasury and investment grade corporate bond yields. In addition, your personal attributes (age, gender) and the policy options you select will impact the quote.

Understanding how your personal attributes and the options you select drive quotes enables you to structure the policy to best suit your needs. Expect to have to think about the following when evaluating longevity annuities:

Age

The longer you wait to buy, the less time the insurance company will have to invest your premium before beginning income payments. Holding all else equal, buying future income today will be cheaper than buying the same amount in the future.

Gender

Income will be higher for males than females. Because women have longer life expectancies than men, the income women receive each year will be smaller.

Premium

Income will increase with higher premiums. A portion of the insurance company's expenses incurred are fixed per contract such that incremental premium can go entirely towards buying income. Said another way, there is usually a discount for larger premium deposits. There are a number of insurers, on the other hand, that price in a linear fashion. That means that small purchases get the same relative value as large purchases. Whether or not an insurer prices this way is noted in the details of the quote.

Single vs. Joint

Income will be higher for single life than joint life policies. A joint life policy will provide income as long as either person is alive, which is almost certainly longer than if contingent on one person.

The income level following the loss of the first life can be designed to remain level or decrease. Opting to reduce the income upon the passing of the first spouse (typically to 40-99% of the starting income level) allows for a greater income level while both are alive.

An alternative to buying a joint life annuity is to purchase a single life annuity with a Refund at Death (cash refund or death benefit) and designate your spouse as the beneficiary. Upon your passing, he/she will have the option to continue the contract in his/her name until any remaining amount of the initial premium has been paid out.

Payout Options

Income can be based purely on lifespan or can have a guaranteed component:

• Life Only: Payments stop at death (or later if two deaths for joint).
• Life with Refund at Death: Additional guarantee over life only that pays beneficiaries the difference between the premium and sum of all payments already received upon insured's death.
• Life with Period Certain: Additional guarantee over life only that guarantees payments for at least a certain number of years. Payments will continue to beneficiaries if the insured passes away during this period of time.
• Period Certain Only: Receive payments for only a specific number of years not tied to the insured's death (not quoted on the website but available upon request).

Income will be lower for richer guarantees. Guaranteeing a minimum cumulative income (Refund at Death) or a minimum number of payments (Period Certain) increases the amount the insurer expects to pay you. To compensate for the extra guarantee, they will need to lower the recurring payments.

Inflation Protection

Most insurance carriers offer an inflation adjustment or annual increase rider that will adjust the annuity income payments annually for inflation. The adjustment made could be predetermined (between 1-5%) or in some cases be based on a Consumer Price Index. Providing these increases will require a lower starting income.

Because inflation affects the purchasing power of money, it presents a challenge for retirement, which could last 40 years. Adding an inflation rider to your income annuity is one way to mitigate the risk of declining purchase power, but it's probably not the most efficient way, as the extra protection will come at a cost. Consider instead more direct ways to earn inflation-adjusted dollars. Your Social Security benefit, for one, will be indexed for inflation through a Cost-of-Living Adjustment. And, for the rest of your assets, maintaining exposure to equity markets and investing in inflation-linked bonds, such as TIPS or I-Bonds, can provide an effective hedge.

Insurer Rating

An insurer's financial credit rating measures their financial strength and ability to meet future obligations. The rating indicates the credibility and ability an insurance company has to repay any claims to customers. Our site uses the ratings of A.M. Best, which specializes in the insurance industry. For income annuities, we only offer carriers with a rating of A or better.

The A.M. Best rating categories are as follows:

• A+, A++ are a superior rating
• A, A- are an excellent rating
• B+, B++ are a good rating
• B, B- are a fair rating
• C-D ratings are rated marginal to poor

From the government's perspective, an annuity is a retirement savings vehicle. As such, it receives the same tax treatment as IRAs: no taxes are paid until distributions are made. The benefits are slightly different depending on whether the income annuity is funded with qualified or non-qualified funds:

The RMD is an IRS-mandated minimum amount you must withdraw from your tax-deferred retirement accounts every year starting at age 73. However, QLACs are exempt from this rule, allowing you to delay distributions until as late as age 85. By moving money out of your 401(k) or IRA and into a QLAC, you can reduce the required withdrawals and associated taxes between ages 73 and 85, allowing more of your money to work for you on a tax-deferred basis.

The exclusion ratio (investment in the contract ÷ expected return) will be applied to each income payment, indicating how much is not taxable, until the full investment in the contract has paid out. Once the investment has been fully returned, subsequent income payments will be fully taxable.

Finally, if a death benefit or refund at death is due to your beneficiaries, taxes owed will be calculated in a similar manner. Any portion of the death benefit that constitutes a return of premium will be received tax-free, whereas benefits in excess of the initial investment will be taxed at ordinary income levels. Either way, the benefit will be passed directly to beneficiaries, thus avoiding the probate process. And, unless your spouse is designated as your beneficiary, the annuity will typically be included in your estate.

It's important to understand the tax implications of income annuities and work with a tax professional to develop a plan that helps to minimize your tax burden.