Tuesday, September 24, 2013

Why Retirees Should Choose DIAs over SPIAs

My new column at Advisor Perspectives is called, "Why Retirees Should Choose DIAs over SPIAs." In the past, I've written about the efficient frontier of retirement income, finding that retirees can best satisfy twin goals of preserving their lifestyle spending needs in bad luck cases and leaving the potential for upside as well through a combination of stocks and SPIAs.  In this new column, I address the issue of what happens if deferred immediate annuities (also sometimes called deferred income annuities or longevity insurance) are added to the universe of choices when calculating the efficient frontier.

DIAs are like single-premium immediate annuities (SPIAs) in the sense that a lump-sum payment is made now to the annuity provider in return for a guaranteed income stream for the remainder of one's life. The difference is that with a DIA, that guaranteed income stream begins at some later date further off into the future, rather than within one year. This allows the DIA to provide longevity protection more cheaply.

In the column, I describe what happens when I add DIAs with different deferral dates into the mix of retiree choices. I find that DIAs with 10-20 deferral periods [i.e. a 65 year-old couple buys a DIA with income beginning sometime between age 75 and 85] result in more efficient outcomes (better downside protection with very little impact on upside potential) than SPIAs. As well, including SPIAs or DIAs result in noticeably better outcomes than leaving everything just in stocks or bonds. Please see the column for more details.