Contingent Deferred Annuity (CDA)

What Are Contingent Deferred Annuities (CDAs)?

Like all annuities, the contingent deferred annuity (CDA) is meant as an income benefit for those in retirement and can offer peace of mind that the owner will not run out of money during their lifetime. 

However, unlike other annuities that require the policyholder to hand over their assets in exchange for a guaranteed lifetime income, the CDA acts as an insurance policy backstopping the value of a retirement account and the income it can produce for the owner. 

When a retiree buys a CDA, they will only receive a benefit in the form of a monthly or annual payment if their insured retirement account drops below a prearranged level. If the value of the account is depleted, it will trigger the annuity to pay out to the policyholder for the rest of their life, thereby guaranteeing a baseline income. There are limits and rules to how these guarantees work.

Longevity risk is one of the biggest threats to your retirement income. Contingent deferred annuities are one way to protect yourself, but they aren’t the right answer for everyone. Make sure you understand how they work and the pros and cons of owning one.

Brandon Renfro, Ph.D., CFP®, RICP®, EACo-Owner of Belonging Wealth Management

As a Certified Financial Planner™ professional and Retired Income Certified Professional®, Brandon Renfro is well-versed in the financial information and strategies needed to meet retirement goals. In addition to co-owning Belonging Wealth Management and assisting clients, Brandon writes regularly for financial publications.

How They Work

One of the biggest concerns for retirees is running out of money later in life, but handing over some or all their money to an insurance company can be hard to stomach. CDAs allow individuals to unbundle the two most important parts of the typical variable annuity: the income guarantee and the underlying investments. 

CDAs offer investors the ability to keep possession and control of their assets but also add the guarantee of lifetime income if needed. CDAs act as emergency income insurance if — or when — your portfolio runs out of money.  

At the time of the contract, the insurer will estimate the expected income produced by a portfolio and guarantee that amount (for instance, $5,000 per month). A CDA will only kick in if the portfolio value has dropped below a certain threshold established at the time of the agreement (typically $1,000 or less). When this happens, the insurance company will replace the monthly income that had been previously produced by the portfolio for the rest of the policyholder’s life. If the portfolio never runs out, the annuity will never be triggered. 

Although only a few companies in the U.S. sell CDAs, it’s important to keep in mind that the annual costs paid to the insurer may be higher with more aggressive portfolio investments. Each insurance company offering CDAs will measure risk differently, so it can be beneficial to shop around and compare your options before choosing any insurance product. However, all guarantees are still subject to the claims-paying ability of the insurer, so researching the creditworthiness of a prospective insurer is vital.  

CDAs vs. Other Annuity Products

A common thread of annuities is the ability to purchase the benefit of safe, guaranteed lifetime income and the peace of mind that comes with it. As pensions have become less common for workers, many retirees seek out the security that annuities can provide. However, there are important distinctions between CDAs and other types of annuities.  

The product that most closely resembles the CDA is the variable annuity with guaranteed lifetime withdrawal benefits (VA/GLWB). Both provide the policyholder with access to stock and bond market investments for potential higher returns over time, but the VA/GLWB product holds these assets in an account owned by the insurance company for the benefit of the policyholder. 

A CDA allows the policyholder to retain possession and control of the assets. This is a major benefit of the CDA product, but it also creates added risk for both the policyholder and the insurance companies offering the CDAs.  

However, CDAs are subject to various regulations and requirements depending on the jurisdiction. To ensure compliance with applicable laws and regulations, it is important to consult with a financial professional or attorney. It is also crucial to stay up-to-date on the current regulations, as laws may change over time. Additionally, It is worth noting that CDAs may be illegal in some states, including New York.

Understanding Risk of CDAs

Investment Risk

The ability of policyholders to control their assets can create investment risk depending on how well they manage their portfolio. A poorly managed portfolio may become depleted faster than expected, impacting their income and the obligations of the insurer. With most CDAs, policyholders are required to invest only in approved options, and deviating from the agreed-upon portfolio structure can compromise the contract obligations. 

Distribution Risk

Policyholders must withdraw a fixed percentage of the account, and increasing this amount for any reason may reduce the benefit offered by the insurer. Unexpected expenses or withdrawals may also have an impact on future guarantees. On the other hand, if the withdrawal is smaller than expected, the benefits may increase.  

Large Depletion Risk

Because the CDA only provides payments in the event of full account depletion, it is highly likely that the policyholder may not see any benefit from the policy. This means that the policyholder may spend their portfolio, leaving little or no assets for their heirs.

Pros and Cons of CDAs

For consumers, there are clear pros and cons for Contingent Deferred Annuities.  

Pros & Cons

Pros

• Potential to receive a guaranteed income amount if portfolio is depleted
• Retain control of your assets
• Protection against longevity risk
• Contracts can usually be canceled at any time

Cons

• Fees that vary between 1.1% and 2.3%, not including investment or asset management fees
• Investors are responsible for managing their own assets
• Benefit guarantee may not apply if the portfolio is not depleted to the required level
• Benefit payments may be reduced if withdrawals are larger than expected
• Availability varies based on state regulations, potentially limiting consumer options and competition among insurers

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How To Know if a CDA Is Right for You

When considering complex financial products such as annuities, especially niche products like a CDA, it’s crucial to do your research and evaluate comparable products from multiple companies. Seeking the advice of an independent financial advisor can also provide valuable insights and help you determine if a specific product fits into your financial plan.

As you weigh your options, consider your need for income and your longevity. Annuities can be a smart choice for consumers who anticipate living longer than average, and CDAs specifically can provide a guaranteed income amount and more flexibility with withdrawals compared to other annuity products. However, it’s important to note that changes to withdrawal amounts can impact future benefits, and policyholders are responsible for monitoring and managing this risk.  

For retirees who are comfortable managing their investments and want flexibility in yearly withdrawals while still wanting to backstop their longevity risk, CDAs may be an attractive option. It’s important to carefully evaluate the fees, potential reductions in benefit payments and state regulatory requirements before making any decisions.