Longevity annuities a good retirement tool?
You might live a very long time. If running out of money in retirement keeps you up at night, a longevity annuity could calm your nerves.
This sort of annuity, generally available from an insurance company and usually purchased sometime during your 60s, doesn’t give you an immediate payout, but kicks in later — often decades later. Once you start collecting it, a longevity annuity guarantees a steady monthly income for the rest of your life.
Recent government moves
Changes to government regulations made in July 2014 make it possible to get such an annuity through your employer-sponsored plan, such as a 401(k), or even in an individual retirement account. The most you can invest in a longevity annuity is 25% of your retirement account balance, or a maximum of $125,000.
That amount is not subject to the government’s required minimum distribution, or RMD, rules that call for payouts from retirement accounts to begin at age 70 1/2. In other words, the amount invested in the annuity will be ignored when you calculate your RMD. This is key because you typically start to collect the longevity annuity payments in your 80s.
In October 2014, the Treasury Department and the IRS further expanded the availability of income annuities through target-date funds in 401(k) plans. Target-date funds provide investments tailored for different age groups and are often the default option for participants who don’t choose their own investments. The new government guidance allows retirement plans to offer annuity contracts in the fixed-income portion of target-date funds, either as a default option or an investment alternative. This means that if you are nearing retirement and haven’t actively chosen to invest in longevity annuities, you might still benefit from them if your plan offers this option.
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Reviews are mixed
While these products are designed to enhance retirement security, not everyone is a fan.
“It is not something we are focused on right now because what annuities pay is very subject to the current interest rate environment, which is historically low,” says Harold Evensky, chairman of Evensky & Katz/Foldes Financial, a wealth management firm in Coral Gables, Florida. But he expects that within the next decade it will become an important vehicle to manage longevity risk — the risk of outliving your money.
Evensky points out that there are behavioral aspects that might make longevity annuities more popular, considering that if a 65-year-old man were to buy an immediate annuity for a monthly payout of $1,000, it would cost 5 times as much as buying a deferred annuity that would start paying out $1,000 a month when he turns 85.
“The downside is that they may not live to 85,” says Evensky. “It’s like any insurance. If they are dead, they won’t care. I tell people, ‘You buy fire insurance and you don’t complain the house doesn’t burn down.'”
Explore your options
Does this mean you should add this additional tool to your retirement plan arsenal?
One downside, if you are a man, is that you might find this a less favorable option in an employer-sponsored defined contribution plan such as a 401(k).
“The goal is a worthwhile goal, but the proposal is flawed in some respects. And the way it is flawed is that for any employer-provided plan it is required, because of a Supreme Court ruling, that the annuity be a unisex annuity,” says John Turner, director of the Pension Policy Center, a Washington, D.C., consultancy.
This means that men and women will purchase an annuity at similar rates if they buy it through a 401(k) plan, even though it is much more likely that the woman will actually live to her 80s and start receiving the payout. As Turner sees it, the man is effectively subsidizing the woman.
However, IRAs aren’t subject to these unisex pricing requirements and thus may be a better option for men looking into this option.
Rollout expected to begin slowly
Turner doesn’t expect that longevity annuities will be widely available through employer-sponsored plans anytime soon.
Few people are taking advantage of immediate annuities because they lose upside potential by getting into a guaranteed lifetime contract, says Scott Spann, a Charleston, South Carolina-based financial planner for Financial Finesse, a firm that helps corporate employers offer financial wellness programs to their employees. And with the deferred annuity option, people will lose even more flexibility.
“There are concerns about longevity insurance and that’s the reason not all employers are offering this,” says Spann. “I think less than 1 out of 5 employers even offer annuities within their retirement plans, and even fewer offer these longevity insurance products. Because of the administrative complexities due to employees potentially leaving, there is a lot of uncertainty there as to how to make these policies portable for employees.”
Longevity annuities are likely to become more widely available through employer-sponsored plans in the future, Evenksy says, with larger plans offering this option first and other plans following suit as people understand the option better.
Of course, you could always set up your own IRA to take advantage of them.
Long-term care alternative
A longevity annuity could be useful if you don’t qualify for a traditional long-term care policy. In that case, you would get the money you need for long-term care at a point when you are likely to need it — whether you need the care or not.
However, some people may need long-term care even before the longevity annuity payout begins, so this is not the best substitute for long-term care needs.
Before going the longevity annuity route, consider the risks.
“The primary disadvantage is that you clearly lose control of those funds; they are no longer yours,” says Evensky. “You may not live for it to kick in. And in general, they are fixed, so they are subject to inflation. And it could be a potential credit risk because you are looking for some company to be around 20 years from now to pay you.”