One of the greatest fear for retirees is outliving their retirement income. One common approach to managing this fear is to maintain a diversified portfolio, cut retirement spending, and make necessary adjustments to future plans. However, for those who have worked hard and sacrificed their entire lives, retirement is the time to finally enjoy the fruits of their labor.
In the past, single premium immediate annuities have been purchased at retirement, but many retirees do not want to commit such a large portion of their capital. Therefore, this type of solution has not been very popular—until now.
A longevity annuity allows for much less capital to be used for a guaranteed lifetime payment. The difference is that these payments are not started until a much later date, usually age 80 or 85, and continue for the remainder of the annuity holder’s life. With required minimum distribution (RMD) requirements stating that 401(k) or IRA distributions must begin at age 70 ½, a longevity annuities later draw date is also appealing for those worried about a continued income stream.
By using the “Annuity Bucket” formula, income can be relied on for the remainder of retirement. Longevity annuities are simply deferred annuities that exchange a lump sum of cash in exchange for a steady stream of income later on in life. Even with today’s low-interest rates, current longevity annuity rates are relatively competitive to returns of a fixed income portfolio. In fact, if interest rates rise, longevity annuities may become standard in the retirement income portfolio.
Longevity of Life and Retirement Funds
Due to a higher quality of life and overall better health care, people are living much longer today than they have in the recent past. Many retirees are living into their 90s and even reaching 100 years old. Unfortunately, according to a 2014 survey conducted by the Employee Benefit Research Institute, only 18% of workers are very confident that enough money will be available for a comfortable retirement. Therefore, longevity planning using existing resources for when a retiree reaches age 80 to 85 ensures that a comfortable retirement can be continued and is quickly becoming a popular addition to a retirement portfolio.
Typically used as a supplemental retirement investment vehicle, generally 10 to 25 percent of a retirement nest egg is invested in a longevity annuity. This money continues to grow until payouts begin. The later the payments are delayed, the larger the payments will be. A longevity annuity is similarly to purchasing a health insurance policy with a large deductible.
For the typical retiree, dedicating 10% of their retirement savings into a longevity annuity will provide around the same spending power as 50% of their savings to other types of annuities that begin with an immediate payout. But, this increased amount comes with some risk. Unless provisions are written into the longevity annuity for beneficiaries, if an account holder passes before payouts begin, the entire balance reverts to the insurance company. Small nuances such as this are why it is advisable to consult a financial expert before purchasing this type of annuity to explore all of the different options.
With an advanced life delayed annuity, constructive planning allows for retirees who approach their 80’s to be assured of a continuous stream of income well after the first 20 years of retirement. Provisions for income continuation for a spouse can also be structured into the annuity. The advanced life delayed annuity also has provisions built in that make annual installment payments to a retiree’s heirs in the event that the retiree does not make it to the point of drawing the income. In this case, annual installment payments are made to the heirs. The peace of mind an advanced life delayed annuity provides is priceless.
When determining the monthly income, two factors are considered:
- The amount of money to commit
- The age that a retiree desires to begin taking lifetime income payments
Changes in the Law
Until recently, account holders were forced to begin drawing on their accounts at age 70 ½. But due to changes in the law, longevity annuities can now be purchased inside of 401(k) and IRA plans, allowing for collection to be delayed up to age 85. This change in the law can help add thousands of dollars to annuity payments.
For example, an IRA has a value of $500,000. Under the new law, 25% of this amount, up to $125,000, can be used to buy a longevity annuity. The amount of the monthly income will depend on when the income is to begin; the longer an account holder waits to draw this income, the higher the amount of the monthly check. In addition, the annuity can be structured so that 100% of the value goes to beneficiaries if the holder does not live to draw the income.
The popularity of this type of annuity is projected to gain in popularity due to the changes in the law. With an easy to understand format, experts predict that in 5 years, longevity annuities will be the number one type of annuity in the country.
Drawbacks to Longevity Annuities
Note that longevity annuities are very different from variable and index annuities which don’t qualify under the new law. In addition, the ability to change the terms of this type of annuity is extremely rigid. The government has put a limit on the amount that a person can put in due to this inability to revert the annuity back to cash. However, it is an excellent option for the vast majority of investors with traditional IRAs.
For those who want more control over their assets, the bucket strategy can be utilized. The bucket strategy simply means that there are three different “buckets” of money—a stock, bond, and cash bucket. However, the main difference in this type of strategy is guaranteed income. Once the buckets of income run out, they are not replenished. With a longevity annuity, no matter the age of the owner, monthly income will continue to be received.