Many people are living longer and retiring earlier. According to the Bureau of Labor Statistics, the average age for men who retired during 1995-2000 was 62.6; for women it was 62.5. Just 45 years earlier (1950-1955) the average retirement age was 68.5 and 67.9 for men and women respectively. Meanwhile, the life expectancy for a 65-year-old in 1950 was 12.8 years for males and 15.1 years for females. By the year 2005, the latest date for which data is provided, this had risen to 17.2 and 20 years respectively.
Undoubtedly, you hope to retire younger and live longer. But have you set up your retirement in such a way that you will be able to finance your dreams? In this article, we take a look at longevity insurance and how you can use it to ensure that your retirement income pays out just as you imagined it would. (To read more about financing your retirement, see Determining Your Post-Work Income and Ten Tips For Achieving Financial Security.)
As individuals continue to retire at earlier ages and live longer, they are faced with the challenge of financing a retirement period that is likely to span 20 to 30 years. Those who are concerned about the probability of outliving their assets should consider seeking investment solutions that will guarantee retirement income for their lifetime.
Insurance Companies Have a Solution
To help individuals guarantee that they will not outlive their assets, insurance companies are offering longevity insurance, a new product that guarantees that you will not outlive your retirement funds.
As with a deferred annuity, your payment accrues earnings on a tax-deferred basis. This is called the accumulation phase, during which amounts that accumulate in the account will fund your future income stream. Under the terms of the contract, the provider will promise to pay you an income amount for life beginning at an age that you choose, provided that beginning-age is available under the plan. For instance, you might choose to start receiving your income stream at age 85, with payments continuing for the rest of your life. (To read more about annuities, see An Overview Of Annuities, Selecting The Payout On Your Annuity and Inflation-Protected Annuities: Part Of A Solid Financial Plan.)
Similar to an immediate annuity, the amount of income you will receive is calculated at the time you purchase the annuity, based on the amount you invest, your age and your rate of return, and can usually begin within a year after your last premium payment.
Premium-payment options include paying in a lump-sum amount, or making level-premium payments at an established frequency such as monthly, quarterly, semi-annually or annually. For the level-premium payment option, the payments are usually required to be completed before you begin to receive your income amounts from the annuity. (To find out more about payments, see Lump Sum Versus Regular Pension Payments, Selecting The Payout On Your Annuity and Pension Law Could Reduce Your Payout.)
Income payments can be over your single life expectancy or over the joint life expectancy of you and your spouse, with payments continuing to your spouse if he/she survives you. They can be made at an established frequency such as monthly, quarterly, semi-annually or annually.
Longevity insurance policies typically do not include the following features:
- Death benefit protection - where your beneficiaries will receive lump-sum payment if you die during the accumulation phase
- Inflation protection - where your income payments will increase based on the percentage you select when opening the account
- Level-premium payments - where you have the option of paying premiums over a period instead of in a lump sum
- Supplemental income - which allows you to take a percentage of the guaranteed amount if you have to go into a nursing home or other eligible facility
However, some providers offer a variation of the product that includes at least some of these features, which may or may not be optional, for a fee.
Hypothetical Case Study
Frank and Margaret are both 60-years-old and hold a 15-year mortgage on a duplex they recently sold. Frank likes the $2,000 that they receive each month from the buyer. He would like that monthly check to continue after the mortgage is paid off. Plus, he's concerned that Margaret might not have sufficient income should he predecease her. What could he do?
Frank could use a fixed, deferred payout annuity with a joint lifetime benefit. By investing $140,000, he would be assured that in 15 years he would receive $2,000 a month for the rest of his life. And if he were to predecease Margaret, the checks would continue for the rest of her life.
However, if they are willing to wait until age 80 for the payments to begin, Frank and Margaret would only need to put away $88,000 at age 60.
|Payout||Income Starts at|
|--||Age 85||Age 80||Age 75|
|Male: Single Lifetime/Cash Refund||$16,000||$31,000||$54,000|
|Female: Single Lifetime/Cash Refund||$19,000||$37,000||$61,000|
|Male & Female: Joint Lifetime/Cash Refund||$24,000||$44,000||$70,000|
Payments will start in your later years, possibly at a time when your other income sources have dried up or when healthcare-related expenses have increased. And you'll know exactly how much income you'll receive, which allows you to work within a realistic budget.
Since you'll know how much income you will receive and the frequency, longevity insurance can eliminate one of the biggest unknown factors for many retirees - how long must the remainder of your portfolio last? This may allow you to invest the rest of your portfolio more aggressively, and may also allow you to gift some of your assets to your loved ones or you favorite charity while you're alive. (For related reading, see Gifting Your Retirement Assets To Charity.)
Fees and Lost Investments
Let's face it, insurance companies are in the business of making money. This means that you will generally need to pay fees for using their products and services. The longevity insurance products are no different. Therefore, you must consider any applicable fees when considering such a product. And as with other annuity products, projections are that you will not live long enough to recoup your premiums and earnings, which means the insurance company will profit from your investment.
Missed Opportunities for Diversification
Having your assets in an annuity will mean that those assets cannot be further diversified. As such; you may miss out on opportunities to play the stock market. Because the payouts are fixed at the time of purchase, they will not increase even if there is a big rise in the DJIA or an increase in interest rates. (To learn more, check out The Importance Of Diversification.)
Even though there is an inflation protection option, it doesn't begin until your payout starts. Consequently, if the cost of living increases significantly during the accumulation phase, inflation may erode some of your projected income.
As an increasing number of individuals realize that their retirement income may need to last for an average of 20 to 30 years, more annuity providers are attempting to provide a guaranteed retirement income stream through longevity insurance products. Different providers are customizing their version of the product to distinguish themselves from the competition. As such, if you are in the market for such a product, be sure to compare the features and benefits of each and work with your financial planner to choose the one that is most suitable for you. It's never too early to take charge of your future retirement income needs, and locking in a lifetime of income can give you peace of mind regardless of the direction the stock market may swing.