Few adults would go without auto, home, life, or health insurance. But the kind of insurance that helps protect against the risk of running out of money in old age is still greatly underutilized. It’s called a deferred income annuity or longevity annuity.
Most people planning for retirement should strongly consider an income annuity, and the Brookings Institute study confirms that. Since the study was released in 2019, economists and retirement analysts at Brookings have continued to advocate for annuities that would pay income to retirees, particularly people aged 80 and above.1
Congress has also moved toward passing legislation that would remove barriers to some income annuities, specifically required minimum distributions that have limited the benefits of lifetime annuities.
How annuities work
The concept behind income annuities is simple. The buyer deposits a lump sum or series of payments with an insurer. In return, the insurer guarantees to pay a stream of income in the future. You can choose when your payment will begin. Guaranteed lifetime income is a cost-effective way to insure against the risk of running out of money during old age.
The main disadvantage is that the annuity has no liquidity. You’ve transferred your money to an insurance company in exchange for a guarantee of future income. People who can’t afford to tie up any of their money shouldn’t buy a deferred income annuity.
Why isn’t there more interest in annuities?
Given that traditional pensions have largely gone away, there should be great demand for income annuities. But there isn’t for several reasons.
- People overestimate their ability to invest money wisely.
- They are also concerned that if they don’t live long enough, the annuity won’t be worth the cost. That’s a poor assumption. The value is in the stability and guarantee of lifetime income offered by the product. A lifetime income annuity insures us for the possibility of a longer-than-average lifespan.
- Annuities are confusing to consumers, in part because of the terminology. Annuities include both income annuities as well as indexed and variable annuities, with variable annuities being primarily an investment vehicle.
Why annuities do well
Why do deferred income annuities work so well? Income deferral is a key part of the equation. The insurer invests your money, so it grows until you begin receiving income. The longer you delay taking payments and the older you are when you start taking them, the greater the payout. Also, buyers who do not live to an advanced old age subsidize those who do. Such risk-sharing is how all insurance works, whether it’s home, auto, or longevity insurance.
SECURE Act 2.0
The House of Representatives has passed the Securing a Strong Retirement Act (dubbed the SECURE Act 2.0), a follow-up to retirement reform legislation enacted in December 2019. The original law took steps to allow the use of annuities in savings plans. The new law contains further reforms to encourage annuities.
In summary, annuity vehicles may help reduce the stress of running out of income during retirement.