Want to have a steady stream of income after retirement for a lifetime? The new rules issued in October by the U.S. Treasury Department and the Internal Revenue Service make this goal easier to achieve by including deferred income annuities in your 401(k) investment options.
As traditional pension plans become extremely rare and life expectancy increases, one of the biggest sources of retirement insecurity is outliving your money. Statistically, an average 65-year-old male will live to be 84, while the average female will reach 86. This means you have to cover for roughly 20 years after retirement. No matter how well you invest up until the point that you retire, you can still have a less than satisfactory retirement if you don't handle your money well.
That's where deferred income annuities come in. They're a valuable tool for creating an income distribution program that is very similar to now-scarce defined benefit pensions, traditional plans that paid you a fixed amount based on your salary. You can preserve your investment capital and make sure that you have a steady income for the rest of your life -- no matter how long you live.
Deferred income annuities came about in 2011. They are similar to immediate annuities. You give a lump sum to an insurance company and they guarantee an income for life. Under an immediate annuity, as the name says, you can get payments almost immediately, while with deferred annuities, the payments start much later. With deferred income annuities, your beneficiaries can receive the principal you invested; usually, once you die, that money is lost to heirs.
Previously, this tool was not among the Qualified Default Investment Alternatives, which retirement plans could use to put employees into. But new regulations clear the way for 401(k) plans to include annuities as one of the choices. This is an important option to have. You can now move your money in a 401(k) plan into a deferred income annuity. You can either begin taking income payments at the time of retirement, or you can allow the money to stay in the annuity and continue to grow, very similar to a fixed index annuity.
The longer that you wait to begin taking distributions, the larger the annuity will be, and the larger your monthly income payments will be as well. Many people are in excellent health upon reaching retirement age, and have no immediate need to begin taking retirement income. By deferring the receipt of income, they can substantially increase the amount they get at a later date. And -- this is very important -- if you die before receiving your payouts, the annuity usually provide a death benefit for your spouse and heirs.
Deferred income annuities must deal with the rules for required minimum distributions, which require savers to take money from any tax-sheltered retirement plans after 70 and a half.
There is a potential workaround. If you want to defer income beyond 70 and a half, you can invest in a deferred income annuity using non-tax-sheltered assets, focused in stocks. This can be a way of earning higher income, since interest rates are currently at historic lows. Annuities usually invest mostly in bonds. Should interest rates return to their historic norms, you can take out a new annuity at the then higher rates and increase your income distributions as a result.
Deferred income annuities go a long way toward solving the generally overlooked issue of how retirement plans provide income for retirees. You may find that it is exactly what you need to make sure you never outlive your money.
Jeff Rose, CFP, is the founder of Alliance Wealth Management in Carbondale, Ill., and also is the founder of the website Good Financial Cents and Retirement by Jeff.
