FIAs With Income Riders vs. DIAs:  Which is Right for You? – Part 4 of 5

FIAs With Income Riders vs. DIAs: Which is Right for You? – Part 4 of 5

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If you haven’t read the first three parts of this series yet, you may want to do so since it will provide you with the background for this post. The first three parts listed and compared 12 features offered by fixed index annuities (“FIAs”) with an income rider with deferred income annuities (“DIAs”). It organized the 12 features into three categories: (a) offered by DIAs, (b) applicable to DIAs, and (c) applicable to DIAs on a limited basis.

DIAs are a unique investment in and of themselves. As such, they offer features that are unavailable in other investments, including FIAs with income riders. This week’s post discusses the retirement income planning benefits that are applicable to DIAs that aren’t present in FIAs with income riders.

Simply stated, a DIA is (a) the income rider portion of a FIA, (b) minus the income start date flexibility, (c) plus potential annual income inflation adjustments, (d) plus potential term vs. lifetime income opportunity.

Income Rider Portion of a FIA

As discussed in Part 2, DIAs, unlike FIAs, don’t have a traditional investment value associated with them. As such, a DIA is a simpler investment to understand than a FIA since it’s all about a future income stream.

Unlike the payments from FIA income riders that represent income withdrawals, DIA payments are annuity payments. This is an important distinction when it comes to income taxation. When held in a qualified plan such as a traditional IRA, 100% of FIA income rider and DIA payments are taxable as ordinary income.

With nonqualified, or nonretirement plans, income withdrawals from nonretirement FIAs are subject to “last-in first-out,” or “LIFO,” taxation. 100% of all withdrawals up to your income amount are taxable as ordinary income with any subsequent withdrawals received tax-free. Since DIA payments are annuity payments, they benefit from more favorable taxation when held in nonqualified plans. Each payment is subject to an “exclusion ratio” that excludes from taxation the portion of the payment that’s deemed to be a return of principal.

Minus the Income Start Date Flexibility

One of the best features of a FIA with an income rider from a retirement income planner’s perspective is the ability to begin income withdrawals at virtually any future date so long as it’s generally at least one year from the date of purchase and you’ve reached a specified age, typically 50. Most DIAs have a specified income start date and, therefore, don’t offer this flexibility. This downside can be negated to a certain extent by purchasing multiple DIA’s with different start dates.

Plus Potential Annual Income Inflation Adjustments

While it may change in the future, FIA income withdrawals, once they begin, are generally fixed amounts that don’t adjust for inflation. Although it isn’t automatic, the income payout from a DIA, on the other hand, can be structured to increase by a specified annual inflation factor, generally ranging between 3% and 6%.

Plus Potential Term vs. Lifetime Income Opportunity

One of the benefits of income annuities in general, including FIAs with income riders, is lifetime income. This also applies to DIA’s, however, you can also structure a DIA for a specified term. The term can be a certain number of years, however, it can be fine-tuned to a specified number of months.

With a known payment beginning at a specified future date for a specified number of months, you know exactly the total amount of income that will be received over the term of the DIA at the time of purchase. This offers three distinct retirement income planning benefits:

  1. Ability to precisely calculate an internal rate of return
  2. Ability to structure income to dovetail with the amount, frequency, and duration of other projected income sources to meet projected expenses
  3. Ongoing income payment to beneficiaries in the event of death prior to the end of the term

So which is right for you – FIAs with income riders or DIAs? Mark your calendar to read next week’s post to find out.

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