Buying a guaranteed retirement income for peace of mind

Many workers long for the sense of security that only an old-fashioned pension can provide. The big insurers are well aware of this, and that’s why many of them are offering new ways for investors to buy and build a pension on their own.

More than a dozen companies have recently begun pitching products, known as deferred-income annuities, that allow individuals to buy the income themselves: They pay a lump sum to an insurer — or make a series of payments over time — in exchange for a guaranteed paycheck for life that begins several years later.

It’s impossible to know whether these annuities are a wise buy for a simple reason — most people can’t predict how long they will live. But if you are trying to protect yourself from outliving your savings, you might view the purchase as an insurance policy. Others might use it as a way to provide some certainty around how much they can spend worry-free, since at least a portion of their income would be guaranteed.

More people are buying into those arguments: Sales of deferred-income annuities jumped to $2.2 billion in 2013, more than doubling from $1 billion the previous year and up from $200 million in 2011, when LIMRA, a retirement and insurance trade group, began tracking their sales. The typical buyer is about 59 and expects to begin collecting up to seven or so years later.

“It is these pre-retirees who are beginning to key in on, ‘What am I going to do for income in retirement?’” said Matthew Grove, head of individual annuities at New York Life. “It’s people realizing that, ‘I can invest in bonds, but I won’t get as much juice. I can buy equities, but I am taking more risk. This is kind of right in the middle, where I am driving income, but I am basically doing it with no risk to myself.’”

You need to part with significant sums to generate the income, but the cost declines the longer you wait to collect the paycheck.

Consider a man who buys an annuity at 68 and immediately begins collecting lifetime income of $1,000 a month, or $12,000 annually. That will cost about $170,000, according to New York Life (and it costs $207,000 to cover a man and a woman who are both 68; women pay slightly more since they tend to live longer).

But if a man bought the annuity at 58 and waited 10 years to collect, he would pay about $100,000 for the same $12,000 in annual income. And if he waited 20 years, starting payments at 78, it would cost less than $40,000.

The top three providers — MassMutual, New York Life and Northwestern Mutual — accounted for more than 90 percent of the deferred-income annuity market in 2013, according to LIMRA, though more companies are rapidly joining the fray. Three insurers introduced new products this year, after five new entrants in 2013.

Deferred-income annuities aren’t new (nor should they be confused with more complex, and often maligned, flavors of annuities, including variable and equity-indexed products). For several years, they were marketed as longevity insurance, where the annuities are used purely as an insurance policy against living too long. The idea: You buy the annuity sometime around retirement, but don’t begin collecting until you’re 85 or so. Academics and policymakers love the idea because using the annuities this way provides a good amount of insurance at a relatively low cost; quite simply, many people won’t live long enough to collect. But the notion never really resonated with many retirees.

“It is a big psychological barrier for folks to say ‘I’m going to give you a big chunk of money and I am not going to get anything back until I am 85 years old,’” said Phil Michalowski, vice president of retirement income at MassMutual.

Instead of waiting until their 80s to begin collecting payments, typical buyers, in their late 50s, take about $100,000 from a retirement account like a 401(k) to buy the annuity and expect to begin collecting in their mid-60s or later. But investors can also choose to buy the product in smaller increments — some providers have minimums as low as $2,500 or $5,000 — over time.

Buying the income when retirement is within sight requires less guesswork. Some people, for instance, choose to buy an annuity to cover any basic living expenses, such as housing and food. “You have a good idea of what your income sources might be and you can potentially close any gaps with income insurance,” said Maria A. Bruno, a senior analyst at Vanguard. “But it is insurance and there is a cost for that guarantee.”

Still, deferred annuities may be a good deal, particularly for those who delay collecting the income, because half of the people buying them will probably die earlier than their life expectancy. That means the premiums they paid remain in the overall pool of money, which benefits people who are still collecting payments. This dynamic generates greater returns on their investment than an individual could generate in the broader financial market, experts say. The fact that the insurance company invests in longer-term — and higher-yielding — bonds as a result helps, too.

“No matter how good a cook or an engineer you may be, you can’t bake this in your own kitchen,” said Moshe A. Milevsky, a finance professor at the Schulich School of Business at York University in Toronto, who said he would wait to begin collecting until 70, or even later. (Many companies require that you start taking income by age 701/2 to satisfy the tax rules that require individuals to take minimum distributions at that time; a Treasury Department official said the department would soon release rules that will enable people to wait until they are in their 80s.)