Want an annuity but don’t want to tie up the cash? Try this

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You may be familiar with annuities. Since fewer employers are offering retirement pensions nowadays, annuities are a way of creating your own retirement income. But if you’re concerned about tying up a large sum of money in an annuity contract, and are willing to forego an immediate payout in return for a larger payout later, a deferred income annuity might be the answer.

Annuities are a way of ensuring a guaranteed stream of income in retirement. For those concerned about outliving their money, annuities can help alleviate some of those fears. The annuities page has more information about annuities.

But annuities usually come with substantial fees, and require you to devote a large sum of cash to purchase the annuity. One answer may be deferred income annuities, Also called longevity annuities, deferred income annuities defer payouts until the purchaser reaches a certain age, typically 80 years or so. When the purchaser reaches that age, the annuity starts paying out. But if the purchaser should die beforehand, the purchase price is forfeited.

The payouts from longevity annuities are deferred, but are much higher than for traditional annuities. For example, a $100,000 traditional annuity purchased at age 55 might pay out $5000 per year for life, while a deferred annuity that pays out starting at age 75 might pay out $24,000 per year.

Longevity annuities are much less expensive than traditional annuities because the risk that the purchaser will never receive any payouts is built into the cost. They are also less expensive because the effects of inflation mean that payouts made decades in the future will be worth much less than immediate payouts. For example, at 2.5% inflation, a payout of $40,000 today would be worth about $18,000 in 35 years. Many insurance companies offer policies with inflation protection included, for a higher price.

As retirees’ lifespans are increasing, deferred income annuities are a way of helping ensure that retirees don’t run out of income, at an advanced age when they become most vulnerable. Such annuities may allow retirees to become somewhat more aggressive in their other retirement investments, since they don’t have to be concerned about depleting their savings.

One downside of longevity annuities is that, once the funds are committed to purchasing the contract, you cannot access them for any reason. Some contracts allow purchasers to withdraw some of the annuity balance early for specific needs such as healthcare or education.

Another disadvantage is that, should the purchaser die before collecting any payouts, the purchase price is forfeited. Some contracts, though, do provide a death benefit that refunds part of the purchase price to your beneficiaries.

These modified contracts with added flexibility come at the cost of reduced payouts. Under a typical $100,000 annuity policy, you might receive $3000 per month instead of $5000 in return for the increased flexibility.

Under recent rules, deferred income annuities can be purchased with IRA or 401(k) funds. The purchase price of a longevity annuity is subtracted from the value of the IRA for calculating required minimum distributions (the amount you must take out from tax-deferred savings accounts starting at age 70 1/2).

So if you use $100,000 of a $400,00 IRA to purchase a longevity annuity, you only calculate RMDs on the remaining $300,000. The conditions are that the annuity must start paying out by age 85, and that you cannot put more than 25% of the value of the account into such an annuity, up to a maximum of $125,000.

Deferred income annuities aren’t necessarily suitable for those with substantial assets. Such individuals are likely better off seeking income from stock dividends, bonds, and other investments. But for others, particularly those in relatively good health with family histories of living into their 90s, these annuities may be the right choice for a portion of their retirement savings.

Before purchasing a deferred income annuity, you might want to consult a qualified financial adviser to ensure they’re suitable for your situation and goals. Also, because the payouts start well in the future, you should make sure the insurer is top-rated for paying claims. A.M. Best Company’s website can show you the ratings for insurance companies. The policy should also stay within your state’s guarantee fund limit for coverage.

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