Choosing an Income Stream Immediately or Deferring It is an Important Decision

Date posted: September 30, 2013

Typically we think there are two choices when you decide the point at which you will receive income from your annuity.  Now, with an immediate annuity, or later, with a deferred annuity are your options.  But in Stan Haithcock’s Martkewatch article, “Annuities: Income now, later – or never,” he points to a third option that more people are actually using.  Believe it or not, a lot of the income riders attached to deferred annuities are never used.  

If you think there is a possibility that you will never use your income rider, make sure to add death benefits to you annuity policy.  That way if you are not using the income, your heirs will be able to receive income payments, usually over a five year time frame.  I am surprised that more people are not annuitizing their income rider, but I equate the actual low percentages to the fact that they have been most popular since the 2008 economic crisis and a lot of the people who bought them are still working.

It’s no secret that Stan recommends using annuities only for income and not for growth.  While we do think that some people will benefit from using variable annuities and indexed annuities to grow their money, we do believe that receiving lifetime income payments is one of the biggest benefits to using annuities.  The decision you have to make is whether you want to start receiving your income now or at a point sometime in the future. 

When using an annuity for income, your value enters the picture at the point in your life when all of the money you put into the annuity is depleted and you are getting your annuity payments from the insurance company’s funds.  The simplest way to receive income now is with a single premium immediate annuity.  Income payments start a month after your annuity purchase and continue for the rest of your life or even the rest of a spouse’s life as well.  Everyone who buys an annuity is hopeful that they will live long enough to enjoy the risk transfer to the insurance company, but the insurance against outliving your money is still worth the annuity regardless.

If you aren’t ready to receive income immediately, you can opt for a deferred annuity.  Just as with the former, the payments of the latter are based on actuarial tables that estimate your life expectancy.  Deferred income annuities are one option for waiting to receive income later.  You can even wait up to 45 years before starting your income stream.  Commissions are low and there are no fees with this pension-like income choice.  The other way to defer your annuity payments is to add an income rider onto any deferred annuity.  

Many people choose the annuity by the type of fixed, variable, or indexed benefits and then add the income rider on.  While Stan thinks the income rider should be the most important consideration, work with your advisor to see the best benefit to your future plans.  If you plan to use an annuity for lifetime income whether it be now or later, great.  

The option of never using the income stream may mean that you don’t need the lifetime income feature because of other sources of income.  If that is the case, look into a different type of annuity for different protective benefits.

Fixed Annuities Provide Most Retirement Income When Future Markets Are Down

Life would be much easier for everyone if we had a crystal ball to see into the future.  Since we don’t, we need to be prepared for all possible scenarios in life, especially when it comes to planning for retirement.  Steve Vernon of CBS Moneywatch uses some helpful graphs to help us “Choose the best ways to generate retirement income.”  When you are figuring out how much income you will receive from your retirement savings, the current economic conditions should only be one of many things you look into. 

It’s important to see how your different options for generating retirement income will change based on good market conditions and bad market conditions as well.  So-called scenario planning is a good way to see how your income generator will work in both best and worst case situations, as well as everything in between.

In the first graph, made by Dr. Wade Pfau, six different retirement income strategies are evaluated in a negative economic future. 

The guaranteed income of the different annuity products performed the best when future economic conditions were negative.  Inflation-adjusted annuities provided the highest income after 30 years out of all six strategies researched.  They were followed by the immediate fixed income annuity, which provided the second highest income after 30 years.  Fixed annuities are not affected by market performance, so when markets decline, they certainly pay off as a good investment. 

Using constant systematic withdrawals, equivalent to the 4% rule, proved catastrophic in a negative economic environment.  Retirement income dropped to zero after 20 years and there was nothing left for the remaining 10 years that were studied, not to mention any additional years that you may actually live.

Both graphs use the same scenario to get their results: a 65 year old couple with $100,000 in retirement savings.  The second graph determines how your inflation-adjusted retirement income would change if economic conditions proved to be more favorable in the future than they are today.  In this scenario, you get the most income from strategies that invest your retirement income and pay you a percentage of that.

This makes sense, but are you willing to take the gamble on the markets being favorable right when you decide to retire?  Since the fixed annuities listed don’t change with the markets, they provided the least income of the studied methods when markets were up at retirement.  But their income was consistent in both graphs, something that provides peace of mind during retirement.

Behavioral science has shown that we as humans are more hurt by financial losses than we are pleased with unexpected financial gains.  What this and these graphs show us is that diversifying retirement income strategies may be the best way to protect and provide income in the future.  

Always be prepared with guaranteed income in case the scenario that you hope to happen is not the true life situation.  By assuming the worst and preparing for that with guaranteed income streams, you are protected either way.  If you want to use some of your retirement savings in the markets just in case the scenario is favorable, that could be a good option too.