With life expectancies on the rise, millions of people are facing the challenge of how to support themselves into their 80s, 90s, and even beyond. Longevity insurance is one possible solution. That's the descriptive name for a specialized annuity designed to begin making lifetime income payments to recipients at a trigger date of their choosing.
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Age 85 appears to be the most common start date for these annuities, but the date can be tailored by the recipient at the time of purchase. Usually, the type of annuity used for this protection is called a single-premium deferred annuity (SPDA), meaning the annuity is purchased with a single payment, and the date payments begin is deferred to a future time.
"It's a very interesting alternative to a traditional annuity," says Anna M. Rappaport, a consulting actuary and chair of the Society of Actuaries' Committee on Post-Retirement Needs and Risks. She notes that devoting a portion of your existing nest egg to such a product will reduce your investment portfolio, and thus your income during the earlier years of your retirement. But this may be more than offset by the income you can earn in your post-85 years. Plus, you'll be certain that you can spend down your portfolio by the time you turn 85 and not worry about outliving your income.
The earlier you buy such an annuity, the less it will cost. That's because the insurance company issuing the annuity will have your money for a long time before it must begin making payments, and it will be earning a return on your premium from day one. Also, the insurance company will generally keep your premium even if you die before the trigger date, and the odds of when you will die are factored into the premium.
Right now, however, low interest rates are depressing the level of guaranteed payments that insurance companies are willing to make on their fixed annuities. Insurance agents familiar with annuities should be able to generate illustrations showing how payout guarantees would change with higher levels of interest rates. These calculations can help you decide on the timing of buying longevity protection.
MetLife has been selling this sort of product for several years. For a $50,000 purchase, the company says, lifetime annual payments for a male beginning at age 85 would be $50,810 a year if the product was purchased at age 55. If purchased at 60, the payments would be $38,000, and at 65, the amount would be $28,600. For women, the comparable income amounts are $40,100 (age 55), $30,190 (age 60), and $22,910 (age 65). The lower payments to women reflect their greater chances of surviving to 85 and beyond. These payments are only about two-thirds the level of guarantees provided two years ago by MetLife when interest rates were higher.
How long will you live? On average, a 65-year-old man will live more than 17 years; a 65-year-old woman will live another 20 years. But these are averages, meaning the odds of living longer are considerable, and they're rising. For someone reaching age 85, living another five to 10 years is normal. Family history, lifestyle, and your health profile are good indicators of whether you should even worry about being around by the age of 85. Online longevity calculators can help you make this assessment.
What's your current retirement spend-down plan? Rappaport notes that many people don't even have a plan, and that building one should be an essential part of any longer-term look at your financial needs. Research by the Society shows, for example, that the value of a retiree's home is a large part of their assets and should be included in their long-term thinking.
Tax considerations. Annuity income is generally taxable, so using a Roth IRA as the holding vehicle for longevity insurance is an attractive solution. Contributions to Roth IRAs are taxable, but withdrawals aren't taxed. Furthermore, there are forms of longevity insurance that include payments to beneficiaries should you die before the trigger date. These products do not provide such attractive post-85 income payments as pure longevity insurance. But they do allow you to hedge your bets, and holding the insurance inside a Roth may permit attractive estate-tax treatment.
What are your estate wishes? Longevity insurance can also be an attractive estate-preservation tool, Rappaport says. Given the likelihood of heavy medical expenses in the later years of life, longevity insurance can provide a substantial income stream for such expenses and thus preserve your estate. You should get legal and financial advice for the estate and tax issues raised by longevity insurance decisions.
Understand your financial risks. Longevity insurance payments won't kick in for 20 or more years for most purchasers. So, as with life insurance, the financial health of the insurer is a major consideration when buying longevity coverage. Insurance companies may eventually be covered by the same types of federal account insurance as banks, but that's not true today. Industry and state programs do exist to protect policyholders, but they are not backed by the federal government. Many annuity insurers have been rocked by steep losses in 2008 and 2009, so make sure you buy products only from those companies with solid financial ratings. A.M. Best, Fitch, Moody's, and Standard & Poor's are the leading ratings firms for insurers.
Take your time. This is an important decision that will have a big impact on the rest of your life. Rappaport notes that everyone's been through a big financial shock in the past few years, and she advises against making any radical changes. "I might be inclined to think about this as a really good long-term strategy," she says of longevity insurance. But she suggests people may want to consider waiting to act until the economy and investment markets have stabilized.