Deferred-Income Annuities Get Favorable Tax Treatment

It wasn’t exactly Christmas in July, but investors got an early present from Uncle Sam in July when the Treasury Department and the IRS changed the tax treatment on deferred-income annuities.  The favorable tax treatment now allows taxpayers to exclude the value of deferred-income annuities, also known as longevity annuities, from retirement account balances used in determining required minimum distributions (RMDs) from retirement accounts after age 70 ½.

Previously the account balances of deferred-income annuities were included in the calculation of required minimum distributions even though the annuity owner typically realizes the income benefit years in the future.  As a result of the ruling, 401(k) and IRA account owners can use up to 25% of their account balance or $125,000, whichever is less, to buy a deferred-income annuity.

So does the new tax ruling mean that a deferred-income annuity is a good choice for you? That answer depends on a lot of questions about your personal financial situation.  A deferred-income annuity is an annuity contract whereby you exchange a lump sum amount today for a lifetime income stream in the future, typically beginning in retirement.

One of the advantages of a deferred-income annuity is obviously the lifetime income that the purchaser can never outlive, regardless of future economic conditions.  In an era where pensions are becoming more scarce this lifetime income promise is appealing to many retirees.  The other advantage to the deferred-income annuity is that you can purchase the income stream for less than he or she would pay for the same income stream with an immediate fixed annuity.

There are several disadvantages to deferred-income annuities however, and these considerations are what make many retirees decide against investing in them.  One disadvantage of these annuities is that they are very illiquid investments.  The money invested is locked up until the deferral period is over, which can be many years or even decades away.   Another big disadvantage of deferred-income annuities is the poor hedging they provide against inflation, as the income stream is not generally adjusted for inflation with most deferred-income annuities.  With retirement stretching twenty five or more years for an increasingly higher percentage of retirees, retirees are very likely to see their purchasing power cut in half (or more) over the course of their retirement with these annuities.

And the final disadvantage is the chance that the annuity purchaser may not live long enough to collect any of the income stream payments.  Or the purchaser may not live long enough to collect the full value of the lump-sum amount invested and the return on investment the annuity provides.

Because of these significant disadvantages, deferred-income annuities are generally more appropriate for retirees who have ample retirement savings to overcome the risks of lack of liquidity and poor inflation protection.  Retirees who have family histories of longevity are also much more likely to benefit from a deferred-income annuity than retirees whose family’s health history isn’t as favorable.

Is a deferred-income annuity right for you?  Give our office a call today at 419-878-3934 so we can help you examine your situation and determine if they are the right investment for your comfortable retirement.