One challenge in investing for retirement is the possibility that you could outlive your savings.
People over 80 are the fastest growing age group in the United States, a trend that the Bureau of the Census expects to continue for the next 40 years.
One consequence of this demographic shift is increased interest in the ways retirement savers may be able to avoid running short of cash as they live into their eighties and nineties.
One relatively new long-term planning tool is an insurance company product known as a longevity annuity. These annuities resemble pension annuities from an employer’s defined benefit plan or the fixed immediate annuities that you might purchase when you retire. The insurance company, in return for a lump-sum payment, promises to pay income for your lifetime.
The difference is that the income doesn’t start right away, or within a year of purchase, as it does with a pension or an immediate annuity. Rather, the starting date is a number of years in the future, based on the age you select. It just can’t be older than 85
Benefits of longevity
You may purchase a longevity annuity through your investment professional or directly from an insurance company. Or, you may make a lump-sum transfer within a tax-deferred IRA or employer-sponsored retirement savings plan, as long as the plan includes this type of annuity in its menu of options.
One of the key benefits of owning a longevity annuity within a tax-deferred plan is that the US Department of the Treasury has ruled that a longevity annuity’s account value is exempt from the required minimum distribution (RMD) provision that applies to tax-deferred IRAs and employer plans once account holders turn 70½.
If you choose to transfer a lump sum to a qualified longevity annuity contract (QLAC), you effectively reduce your IRA or defined contribution (DC) plan balance. This, in turns, reduces the amount you would otherwise need to withdraw each year from your tax-deferred accounts until you begin receiving income from the QLAC. This may add to the annuity’s appeal, particularly if you have a substantial IRA or DC balance and would be required to take large taxable withdrawals when you don’t really need the income to live comfortably. There is a catch. You can’t transfer everything from your IRA or retirement savings account to a QLAC.
The limit is 25% of the account’s value or $125,000, whichever is less. However, the dollar amount is slated to increase over time in response to increases in inflation.
The annual amount you’ll eventually receive from a longevity annuity is based on four factors:
- Purchase amount
- Current interest rate
- Your age when you purchase the annuity
- Age at which you plan to begin receiving income
Obviously, the larger the principal, the higher the rate, and the longer the time between purchase and payout, the more you should expect to receive. However, if you die before the annuity payments begin, many contracts state that no payouts will be made.
Some newer contracts, though, guarantee return of principal to your account, and so to your heirs, if you die before the full amount has been paid out in benefits. The drawback of this protection is that the amount the annuity will pay you, if you do live long enough to collect, is substantially reduced. Other riders, which provide principal protection or inflation protection, may be available as well, though they also significantly reduce your payout.
Pros and cons of longevity annuities
There are some potential advantages to a longevity annuity. If you’re in good health and can reasonably expect to live a long time, the expectation of a regular income stream from the longevity annuity may make you more comfortable about how you manage your money earlier in retirement. It may also ease any concerns you may have of becoming a burden on your family or needing income to pay for long-term care.
On the other hand, once you’ve purchased a longevity annuity, you’ll have no access to the money even if you need it for unexpected expenses. Further, since all longevity annuities have a fixed rate of return, the future income that you’re promised when you purchase the contract is likely to have more limited buying power when you begin receiving payouts than it does at the present, thanks to the impact of inflation.
Options to consider
If you have $125,000 available to purchase a longevity annuity, you might want to work with your financial adviser to explore alternatives that have the potential to provide a stronger return and so more future income. One example is a Roth IRA, from which no distributions are required. Withdrawals are tax free, while payments from a longevity annuity are not.
Another alternative is a managed account, which can gradually be reallocated to focus less on growth as you grow older and more on income-producing investments. You might also consider a target date or target risk fund. The difference, of course, is that none of these approaches guarantees you lifetime income.
If you do decide that a longevity annuity makes sense for you, you’ll discover that each insurer’s calculation of future income will vary somewhat from the others. An adviser can help you evaluate whether that’s the result of higher fees or a different assessment of future interest rates. You should also evaluate the financial standing of the insurer issuing the product. Any future income will depend on the claims-paying ability of the issuing company.
Income For Life With Longevity Annuities. Pros and Cons by Inna Rosputnia
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