Delayed Income Annuities: The Ultimate Marshmallow Experiment

By John Rafferty
InsuranceNewsNet Magazine, October 2011

"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, will power, 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 their 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 suspect it was something 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 of Stanford University put 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 marshmallow … and some couldn’t wait and ate the marshmallow within the timeframe. 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 greater 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 does 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 their premium payment to collect the benefits of a significant lifetime income, starting perhaps at age 85.

Delayed Income = Current Satisfaction

Ironically, 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 factor 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 preretiree 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 he has 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 (401k, IRAs, non qualified accounts, etc.) need to be managed. Let’s take the case of our 55-year-old preretiree. Without the backstop of a delayed income annuity, prudence may dictate that he assume he lives 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 dies 10 years into retirement yet spent his assets as if he’d live 35 years, his lifestyle 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 only need to last to age 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 only has value 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, marketing at American General Life Companies. American General Life Companies, www.americangeneral.com, is the marketing name for a group of affiliated domestic life insurers, including American General Life Insurance Company and The United States Life Insurance Company of New York. American General Life Companies insurers offer a full line of life insurance, annuities and accident & health products to serve the financial and estate planning needs of its customers throughout the United States.