Delayed Income Annuity: The Ultimate Marshmallow Test
“Deferred gratification and delayed gratification denote a person’s ability to wait in order to obtain something that he or she wants. This intellectual attribute is also called impulse control, willpower, self-control and ‘low’ time preference, in economics. Hence, in formal accounting terms, an investor should calculate the net present value of future rewards and defer near-term rewards of lesser value.” (Wikipedia)
Wow—who knew it could be this simple? If this kind of simple analysis is all that is required to make wise choices that likely require delayed gratification, I think we can probably light up the sales charts with the ultimate delayed gratification product: the delayed income annuity. For a given premium amount today, a 55-year-old can essentially create a structure to receive guaranteed lifetime income beginning in his or her later years and fend off worries about being both old and poor. Sounds like a winner, right?
Not so fast. We live in an instant gratification world, where even pop culture laughs at the idea of delayed gratification. Who doesn’t recall the Seinfeld episode where Elaine wants retribution against a snooty clothing store owner, and she asks the bumbling Kramer to cook up a scheme to put the store out of business? Kramer, as only Kramer can do, tells Elaine in conspiratorial fashion that he’s removed the desiccants from all the garments, and that in five years’ time, those clothes will all be moth-eaten and thus drive the business to ruins. I don’t exactly recall Elaine’s reaction, but it was some-thing like, “You’re an idiot.”
Is the ability to make coldly rational choices that require delayed gratification something that can be learned and appreciated, or is it hardwired? In 1972, research conducted by Professor Walter Mischel ofStanfordUniversityput this question to the test by studying a group of 4-year-old children. Each child was given one marshmallow but promised two if he or she could wait 15 minutes before eating the first marshmallow. You can guess how this went—some of the kids waited and received the second marsh-mallow… and some couldn’t wait and ate the marshmallow within the 15-minute time frame. After the test, the research continued, with the participant children’s developmental progress charted into adolescence. The upshot is that the children who waited more than 15 minutes to eat the first marshmallow were psychologically better adjusted, more dependable people and, as high school students, scored significantly higher grades in the collegiate Scholastic Aptitude Test.
So it appears, if one extrapolates the results and thesis of this experiment, that only those fortunate few who are born with an extra dose of impulse control will ever see the value in what is perhaps the most extreme example of a delayed gratification product—the delayed income annuity. After all, the delayed income annuity really provides the most economic benefit by having the purchaser wait 25 or 30 years after the premium payment to collect the benefits of a significant lifetime income, starting perhaps at age 85.
Delayed Income = Current Satisfaction But the actual benefits payable under a delayed income annuity, i.e., the income stream that is promised far in the future, are not the only things to consider in an overall retirement income portfolio strategy. The delayed benefits themselves may not even be the primary factor. After all, it’s a real stretch to expect an enthusiastic reception from a 55-year-old pre-retiree about how much income he’ll collect in 20 or 30 years’ time. It’s akin to telling a teenager that hard work and diligence over the next several years may result in the kind of career that will afford him that Ferrari on the poster that is plastered on his bedroom wall.
More to the point as to the value of this product, the incorporation of a delayed income annuity within a comprehensive retirement income portfolio creates what amounts to a finite and relatively short period over which a retiree’s remaining liquid retirement accumulation assets (401(k), IRAs, non-qualified accounts, etc.) need to be managed. Let’s take the case of our 55-year-old preretirement. Without the backstop of a delayed income annuity, prudence may dictate an assumption that he will live a very long time, perhaps 30 years or longer in retirement, necessitating extreme caution regarding how he draws down and spends his retirement assets. This may result in his living a lifestyle far more austere than might have been necessary. Trips may be forgone, dinners out eaten instead at home, even grandchildren visited less often. Assuming he spends his assets as though he expects to live 35 more years, but dies 10 years into retirement, his life-style was clearly not optimized.
In contrast, consider the 55-year-old who is in the final 10 years of his working career and decides to backfill his retirement income in the future. In other words, he is willing to pay a premium today to ensure that he can enjoy his retirement lifestyle in the earlier, healthier years of his retirement, spending with less worry (but not with impunity) since his assets don’t need to last for an indefinite period of time. If he knows, for example, that his liquid retirement assets need to last only from age 65 to age 80 or 85, he can more accurately plan what he can safely spend during that time, and thus have the peace of mind to enjoy his retirement with less worry. If he lives to age 80 or 85 and his retirement assets are depleted, the delayed income annuity kicks in and creates the lifetime income he still requires. If he doesn’t make it that long, his heirs may get back the premium if he chose that option, or get back nothing if he didn’t.
Whatever the case, don’t make the mistake of assuming the delayed income annuity has value only for those who live long enough to collect the payments. What may be the key value lies in the added confidence and spending opportunity during the go-go years of early and middle retirement, for those with the foresight to build this product into their retirement portfolio. In other words, there’s no need to wait for the second marshmallow when you own a delayed income annuity.
John Rafferty is vice president of marketing at American General Life Companies and offers a full line of life insurance, annuities, and accident and health products to serve the financial and estate planning needs of its customers throughout the United States.