Many of us plan to live long lives. But with a high life expectancy comes a longer retirement. That means finding ways to financially support ourselves past our working years is more important than ever. There are many options out there that retirees use to boost their retirement income, from defined benefit plans to equity investments. Another available option is called a contingent deferred annuity (CDA). Like other longevity annuities, CDAs provide consumers with an alternative way to access a guaranteed lifetime income. If you’re looking into a CDA, a financial advisor may be able to help you figure out how one can work into your financial plans. Check out SmartAsset’s free advisor matching tool today.
What Is a Contingent Deferred Annuity?
A contingent deferred annuity, abbreviated as CDA, is a type of insurance product. It establishes a contract between a life insurance company and the purchaser of the CDA. With it, the insurer must meet an obligation to make scheduled payments over the course of the annuitant’s lifetime. CDAs only release these payments once designated investments (not owned or held by the insurance company) are depleted. The contract specifics what level of depletion is necessary, either due to market performance, fees, charges, or contractually permitted withdrawals.
Breaking that down, CDAs are a lifetime benefit. However, the benefit is contingent on the customer’s associated investment account balance dropping below a predetermined threshold. As long as the balance remains above that lower limit, the CDA cannot pay out its benefit.
The insurer regularly tracks the approved investment account and adjusts its annual withdrawal limit according to it. The main factors the insurer uses are the asset balance and risk. If the customer contributes more to the account, the insurer adjusts the withdrawal limit upwards. Likewise, if the withdrawal is too great, the insurer adjusts the limit downwards.
Contingent Deferred Annuity Example
Consider an individual who obtains an initial CDA coverage amount worth $1,000,000. Their contract states that they begin receiving their benefit once the account drops below $1,000. At that time, they may withdraw the approved annual amount of $5,000.
Their payout starting age is 60 years old. However, their account eventually drops down to $987. As a result, they hit their benefit trigger amount and start receiving their CDA benefit. This lasts until they die.
Benefits of Contingent Deferred Annuity
There are a couple of risks each retiree should account for while planning. One, in particular, is known as longevity risk. Essentially, this risk refers to the possibility that you outlive your retirement savings. As a result, you are forced to rely solely on Social Security and either Medicare or Medicaid. A CDA provides some protection against this risk through its guaranteed lifetime income payments.
In addition, the account tied to the CDA falls under the responsibility of the purchaser or their agent. They don’t need to transfer any of the funds or securities to the insurance company. This allows the customer to stay invested in the market and potentially earn higher investment returns.
The way CDAs work creates a lifetime income floor for any purchasers near or at retirement. At the same time, the purchaser can still take advantage of possible market returns.
Risks of Contingent Deferred Annuity
CDAs are essentially stand-alone guaranteed living withdrawal benefits. And while they offer certain benefits, they are not exempt from risks. In particular, their pricing can be a potential problem.
CDAs are complicated products, making their fee structure equally complex. As a result, the benefits and drawbacks of the product may not be fully transparent to the customer. However, due to the potential advantages, you can expect the cost to be high.
In addition, CDAs’ similarity to variable annuity contracts means there may be shared risks between the two. In particular, there may be issues regarding the guaranteed living benefits. Since the responsibility for your investments remains with you, there is also the standard market risk.
Is a Contingent Deferred Annuity Right for Me?
CDAs ensure you receive guaranteed living benefits and maintain control over your investment assets. But while a CDA can be an effective shield against longevity risk, it may not suit all consumers.
However, CDAs’ policies are contingent on the covered assets dropping below the minimum threshold. So, your benefit is withheld until you deplete all of your assets. As a result, a CDA works best if you have a risky portfolio. But it can also be an effective tool for anyone facing retirement who fears running out of funds.
Still, some customers may be prepared to face longevity risk as part of retirement. Thus, eliminating the main cause for purchasing a CDA. Even more may prefer alternative approaches to their retirement income gaps. So, ultimately, purchasing a CDA should reflect your future financial needs.
Nowadays, there are multiple retirement income gaps that each worker needs to fill. CDAs are one way to fill that gap. However, it is not the only way. If you see a need to improve your retirement income, consider all of your options. You may want to opt for low-stakes investments through a brokerage account. Or, you might think about renting out a property as a potential source of passive income.
Tips For Retirement Planning
- Planning for retirement comes with its fair share of hurdles. If you want to avoid potential pitfalls, consider working with a financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- A lot of retirement planning relies on projections. You need to guess how much you’ll need in the future to save enough in the present. SmartAsset’s retirement calculator is another free tool that can help. It provides you with an estimate, showing you if you’re currently on the right savings track.